The main point:
Futures contracts have a limited life and will expire based on their respective calendar cycles.
When a contract expires, a process known as settlement begins when the exchange closes all open positions in the expiring contract.
A roll over is the transition from an expiring front month contract to another contract in the following month.
Bitcoin is expected to experience a wave of volatility as more than $8 billion worth of BTC derivatives contracts are set to expire soon. With open interest for BTC futures and options contracts at an all-time high, expiration day could bring Bitcoin back into action.
This article will provide a better understanding of futures contract expiration and its impact on the value of BTC. First, we'll explain the entire futures expiration process, then dive into why market volatility tends to increase on these days and how to get through them safely.
Understanding Futures Expiry
Futures contracts have a limited life and will expire based on their respective calendar cycles. For example, our BTC Quarterly 0625 will expire on the specified date mentioned in its contract specifications – June 25, 2021. This date is known as the expiration date.
On Binance Futures, quarterly contracts expire on the following calendar cycles – March, June, September, and December. When the current front month contract expires, the next contract will replace it as the new front month contract.
For example, the current front month is a September contract. Upon expiration, the December contract will become the new next month.
When the contract expires, a process known as settlement will begin. Settlement is a procedure managed by an exchange to close all open positions in an expiring contract. Generally, futures settlement takes two main forms:
Physical - The trader is required to take delivery or deliver a specified amount of the underlying asset of the contract.
Financial - The trader's account balance is adjusted to reflect the realized profit or loss at expiration.
At Binance Futures, all contracts are financially settled. This means there is no exchange of the underlying crypto assets. Once futures are settled, the corresponding settlement P&L will appear in your wallet balance.
On expiration day, all expiring open positions will be settled at the price determined by the exchange. This price is known as the 'Settlement Price'.
The settlement price is the average price index every second during the last hour (between 14.00 and 15.00 WIB) before delivery. Upon settlement, a settlement fee is charged equal to the taker fee for all positions settled by the expiration date. Note that you are only allowed to close positions, but not open new positions 10 minutes before settlement.
Understand Binance Futures settlement and surrender on our support and FAQ pages.
What Can Traders Do on Futures Expiry Dates?
Before expiration day, you have three options:
Close position before expiration.
Roll over from next month to next contract.
Let the contract expire and settle.
Most short-term traders exit their futures positions before expiration day. The goal is to avoid unexpected volatility and the hassle of contract settlement.
For example, a long-term position trader wants to maintain a futures position in the underlying product. In this situation, traders can place trades in other futures contracts with more distant expiration dates. This action is known as Roll Over.
A roll over is the transition from an expiring front month contract to another contract in the following month. The contract is rolled over to a different month to avoid costs and obligations associated with completing the contract.
How Do Traders Roll Over Futures Contracts?
To roll over a futures contract, one simply sells their open position in the front month contract and simultaneously buys another contract in the following month. For example, if you bought 10 BTCUSD September contracts, you would sell the September 10 contract and buy the December 10 contract.
Traders will determine when to roll over by comparing volume and liquidity on the expiring contract and the following month's contract. Typically, volume and liquidity on expiring contracts will decrease as the expiration date approaches. When volume and liquidity on expiring contracts are significantly lower than the following month, traders will roll over.
While you can roll over on the expiration date itself, you should roll over a few days before the expiration date. Low liquidity on expiration day can result in larger bid-ask spreads and cause slippage.
How Does Expiration Day Impact Liquidity and Asset Volume?
As a trader, you must understand the impact of futures expiration as it will affect your trading results and exit strategy. You should especially be aware of the impact of liquidity and volume on your trading operations in this period.
Liquidity affects your ability to buy or sell assets at a fair price. Liquidity is very important in the futures market because the absence of it can result in slippage that affects overall transaction costs. Thus, traders tend to gravitate towards contracts or markets with high liquidity in order to trade as efficiently as possible.
As traders roll over to new futures contracts, the liquidity of expiring contracts will decrease substantially, then migrate to contracts in the following month. As a result, the bid-ask spread in expiring contracts will widen, increasing transaction costs significantly. Thus, traders with positions in expiring contracts are always encouraged to unwind their positions before such an event.
How Do Futures Expiries Impact Bitcoin Prices?
How is the Bitcoin value affected on the expiration date compared to the non-expiration date/Friday? Comparatively, expiration dates for large derivative markets such as stock options or commodity futures tend to drive more volume and volatility of their underlying assets, as traders rebalance or unwind their positions.
The surge in derivatives contract trading activity resulted in increased price volatility, both in the derivatives market and the underlying assets. Additionally, profit-taking by short-term traders also creates more volatility during this period. This creates a spill-over effect to the underlying asset as the derivatives market experiences increased volatility as expiration approaches.
The following observations (from January 2018 to April 2020) examine Bitcoin's historical performance leading up to its expiration date.
Source: Interdax
As shown, the average daily returns for bitcoin on expiration days are significantly greater than non-expiration days/Fridays. Bitcoin's average return on expiration day is around 1.20%. In contrast, Bitcoin's average daily return is below 0.40% for non-expiry Fridays, while the average daily return for all non-expiration days is below zero.
Source: Interdax
Another observation is that Bitcoin's historical performance before and after the expiration date displays a similar phenomenon. Bitcoin's 7-day average return before expiration is slightly positive at 0.22%, while its 7-day average return after expiration is much stronger at 0.8%.
The above observations show that expiration dates have an impact on Bitcoin's market value. In particular, expiration dates tend to drive more Bitcoin price volatility, as traders change their portfolio positions and move their capital from one contract to another.
Based on these observations, traders and investors should implement stricter risk management around contract expiration periods.
The futures market is an important vehicle for managing risk and increasing market liquidity. Long-term traders, investors, and miners should have many options for hedging or managing these risks that occur periodically throughout the year.
With Binance quarterly contracts, users can better manage their positions and profits amidst market volatility as the expiration date approaches.
Hedge your positions with Binance Bi-Quarter contracts now!
Get Ready for the Expiry Date!
Contract expiration and settlement can have a significant impact on the trading operations of both a hedger and a speculator. It's important to understand the intricacies surrounding futures expiration and settlement.
If you are going to trade futures, be sure to understand the specifics of their contracts and your obligations.
Read these helpful articles for more information on Binance Futures:
(Blog) 10 Reasons You Should Trade on Binance Futures
(Blog) Crypto Futures Trading: What You Need to Know before You Get Started
(Blog) Crypto Futures Risk and Money Management: 5 Things You Can Do to Better Manage Trading Risk
(Support) Binance Futures Product & Features Overview
(Academy) Psychology of Market Cycles
And many more Binance Futures FAQ topics …
Disclaimer: Crypto assets are volatile products with a high risk of losing money quickly. Prices can fluctuate significantly on any given day. Due to these price fluctuations, your holdings may increase or decrease significantly at any given time. This may result in the loss of all capital you have invested in a transaction.
Therefore, you should not trade or invest money that you cannot afford to lose. It is important that you fully understand the risks involved before deciding to trade with us based on your financial resources, level of experience and risk appetite. If necessary, you can seek advice from an independent financial advisor. The actual profits and losses you experience will vary depending on many factors, including, but not limited to, market behavior, market movements, and the size of your trade. Past performance does not determine future performance. The value of your investment may rise or fall. Learn more here.
