Cascading

The process of decomposing longer tenor Exchange traded derivatives (futures and swaps) contracts for the equivalent shorter contracts

Detail

Let's start with an example - a trader buys a futures contract for delivery for the whole of 2018, a so-called Cal-18 contract

Every day that contract is available to trade, and the Exchange publishes a settlement price for that contract that determines daily margining

At the time of trading (2014) the Exchange does not offer any other contracts covering 2018 - months or quarters for example

At the end of 2017 the trader wants to keep the position open, but the Exchange can't continue to publish a Settlement price for the 2018 yearly contract because it can't be traded (the delivery period has already started)

By this time the Exchange is offering Quarters contracts covering the whole of 2018, and Month contracts covering at least the first three months of 2018

So the Exchange, the Clearing broker and the trader all cascade the year contract into four quarterly contracts; Q1, Q2, Q3, Q4 2018.

Q2, Q3 and Q4 are all still tradable, but the Q1 position needs to be closed out, or itself cascaded into three months, January, February and March

As you've probably realized the January contract will very soon be untradable, so it needs to be

  • Closed out - the trader flattens his position in that contract
  • Taken to or exchanged for an equivalent physical contract 
  • (for financial futures) taken into financial settlement

By cascading longer contracts into shorter contracts shortly before the longer contracts begin delivery the Exchange can effectively offer a small set of monthly, quarterly and yearly contracts, that have monthly granularity in the short term, but cover a period of years into the future

As an example EEX are quoting the following Phelix Futures contracts at the time of writing (11 November 2014):

  • Months - usually current month + next nine months - November 2014 to August 2015
  • Quarters - next eleven Quarters - Q1 2015 to Q3 2017
  • Years - next six years - 2015 to 2020

(If you're wondering why November 2014 is still being quoted then that's because it is financially settled through the delivery month - the contract is not tradable in November)

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