What is Roll Over ? How to understand it? How to use it?

Interpreting rollover statistics

Though rollovers are a regular monthly occurrence, understanding rollover stats and interpreting them may hold many a cue for those who dabble in derivatives.

As for the others, here is why interpreting rollover stats is considered an indispensable art for derivatives traders.

But before we get into the nitty-gritty of the interpretations from the rollover numbers, let us first understand what rollover is and how it can be arrived at.

What is rollover?

Rollover, in simple terms, is carrying forward a particular month’s derivative positions to the next month.

This is done by closing the derivative position in the current month and in its place taking a similar position in the subsequent series. To give an example, if you are bullish on the Nifty when your current Nifty future contract is likely to expire soon, you can rollover or carry forward the Nifty future position by buying the subsequent month’s contract and closing the existing position that is due for expiry.

That is, if you had a May month Nifty futures contract bought at 5600, you can roll it over by squaring it off (selling it) and buying a June month Nifty futures instead. In essence, rollover occurs when you book profits or cut losses on your current month contracts and take up a new position in the next month’s contract.

As the price differential that exists between the same contract with two different expiries begins to converge only during the week of expiry, rollovers generally gain momentum only a few days before the expiry.

How to calculate Rollover?

The percentage of rollover of a particular series of the overall market can be arrived at by dividing the open interest of the new series by the total open interest of that series, or the market as a whole.

So, a high rollover percentage is a positive indicator that would suggest that quite a few new positions are being created in the next month contracts. On the contrary, a lower percentage would point at weaker market sentiment, wherein traders either close their current month positions or let them expire, but do not wish to initiate new contracts for the next month.

Open interest refers to the total number of open contracts on a security. That is, the number of futures contracts or options contracts that have not been exercised, expired or fulfilled by delivery.

What are the interpretations?

To best understand the various implications of the rollover trends, assume that you have suffered huge losses on your derivative positions.

In such a scenario, it is unlikely that you would immediately take up another position in the next month contracts. And this is where the first and basic interpretation comes in, from rollover statistics.

If the rollover stats are healthy, it can be safely assumed that the risk appetite of most traders is holding well - an assurance very crucial for derivative traders.

However, if the percentage of rollover is abysmally low, it suggests that derivative traders are not willing to take risks and carry forward their positions.

To put it in perspective, the rollover numbers in most of the months prior to the steep correction in January 2008 were healthy.

But, the rollovers of contracts in the months following that were weak. Not a surprise given the extent of correction that followed in the broad markets.

But, rollovers of positions when seen on a standalone basis do not imply any bullishness or bearishness in the stock or index under consideration. Rollover trends have to be studied along with patterns in price movements of the stock or index. Rollover of positions can be considered bullish only if they are accompanied with a rise in price. Alternately, if the positions are rolled over and prices fall, it can be construed as a sign of bearishness.

So, if a particular stock series has reported above average rollover and has also seen a significant prise rise, you can consider buying at-the-money or out-of-the-money call options on it.

This is because, the general bullish undercurrent in the stock will be positive for the call options’ premium. Alternately, traders with a higher risk tolerance can even consider going long in the stock futures. On the other hand, if the trends point at a weakening sentiment, traders can consider buying the relevant puts.