Switch

What Is a Switch?

A switch, otherwise called "rolling forward," is a futures trading strategy including closing a close to month contract and opening a later month contract with the proceeds. Switching isn't equivalent to spread trading. In a switch, the trader just claims each position in turn. In a spread, the trader is all the while both long one contract and short an alternate yet related contract.

How a Switch Works

Traders utilize a switch when they wish to keep up with their current positions and exposure in contracts that are approaching expiration. The investor could remain bullish or bearish on that specific market past the expiration date of their holdings. Or on the other hand, they might wish to stretch out settlement to keep away from costs of delivery, fees, and different expenses.

Illustration of a Switch

For instance, suppose that it is currently January 2018, and an energy company that will have 500,000 barrels of oil to sell in June 2020 needs to hedge its position. Be that as it may, the company doesn't purchase the July 2020 oil futures contract since they consider this contract too illiquid and thinly traded. The ideal contract has a delivery period of something like 13 months in advance.

In this way, a potential hedging strategy for the company is to sell short the proper number of July 2019 contracts. Then, in June 2019, it could close out the July 2019 position and switch to the July 2020 contract.

Different Forms of Switches

Options traders additionally use switches, in light of the fact that as with futures, these options have expiration dates. Switching is beyond the realm of possibilities in the equities market since stocks don't lapse. For both a futures and an options switch, it is equivalent to a "roll over" or "roll forward." Basically, the trader broadens the expiration date for their exposure to the market.

For options, the trader might change the strike price for the new position. Closing the current options position and opening another trade at a higher strike price, and conceivably with a later expiration date. The utilization of a higher strike and later date is called "rolling up." Closing the current options position and opening another position at a lower strike price, and perhaps with a later expiration date, is called "rolling down."

Risks of Switches

The greatest risk a switcher takes is the possibility of extending or contracting spreads between the contract month sold and the contract month bought. For instance, assuming that the spread between the current month contract and the accompanying contract extends close to switching time, it could cost altogether more to buy the later month than the proceeds received from the close to month. Rolling a short position into longer expiration would benefit from such an enlarging of the spread.

Spreads can broaden for some reasons, from simple seasonal supply and demand to exogenous factors, for example, an impermanent shortage of the underlying commodity due to a production facility closure or war.