Thread on which futures contract to trade, seems relevant given what just happened in Oil.
1 Don't trade the front unless you have to! There are several reasons for this:
1a Physically settled contracts can have technical delivery issues, as we've just seen in Oil. Another example would be a shortage of bonds in the cheapest to deliver basket, perhaps because the Fed has bought them all.
1b Cash settled contracts are subject to manipulation just before the expiry.
1c Often the return distribution on the front contract is deeply evil. For example, front STIR contracts in the ZIRP had almost no volatility and so were super expensive to trade and required insane leverage. Front VIX contracts have horrific skew and kurtosis.
1d It is nicer to calculate carry as the differential between a further out contract and a nearer contract; you can't do this if you hold the front.
2 Liquidity. Almost always better at the front and gets worse. Some contract months are quoted but hardly anyone trades them, eg August Gold.
3 Points one and two are often contradictory! Often we have to trade the front because it is the only contract liquid enough: Equities, FX and Bonds. Usually the second contract is liquid enough: eg Vol, Nat Gas
4 It makes life easier if for seasonal commodities you hold a fixed month, eg December Crude, July Wheat.
5 We have almost a free choice with STIR. I like to go out a few years where there is still liquidity but the vol is more pleasant.
6 If you are stuck holding the front, roll it as soon as possible i.e. once there is enough liquidity in the second contract. Obviously if you are in the second or further contract make sure you roll before it becomes the first contract...
7 One last thing, every time you roll it costs money. So if the market is expensive, and if you can, space out your contracts more. If a contract trades quarterly, but the first two contracts are liquid, then you could roll every 6 months.
8 Most brokers will close physically settled positions if you forget to roll. But you really ought to remember to do this yourself. Don't forget that IMM FX are 'physically settled' in the sense you have to do a cash FX trade if they're delivered, and many brokers allow this.
9 Very occassionally it can make more sense to allow a cash settled position to deliver without rolling. There is a cost saving here, if you are not using a calendar spread to roll then you will only pay the cost of establishing a position in the next contract. But price risk...
