FRM Exam Part I · Futures Markets

Rolling a Futures Hedge Forward and Hedge Accounting Issues

Updated 11 October 2026

Rolling a hedge forward means closing a near-dated futures contract and opening a later one when your exposure lasts longer than available contracts. It creates basis risk at each roll, and daily margin creates liquidity risk. Accounting and tax rules decide when hedge gains and losses hit reported profit.

Understand Futures Pricing, Rolling and Hedge Accounting Issues

Futures contracts have limited maturities. If you need to hedge an exposure that lasts longer than the available contracts, you use a short-dated contract and replace it before it expires. This is called rolling the hedge forward. You close the expiring contract and open a new one with a later delivery date. You can repeat this many times.

Rolling adds risk. The hedge is only perfect if the futures price moves one-for-one with the exposure. At each roll, the spread between the two contract prices matters. In contango (far contracts dearer than near contracts) a long hedger pays to roll; in backwardation (near contracts dearer than far contracts) a long hedger gains. For a short hedger the signs reverse. This is roll-over basis risk. You do not know in advance what the spread will be when you roll.

The second risk is liquidity (funding) risk. Futures are marked to market daily. If prices move against your hedge, you must pay variation margin in cash right away. The loss on the futures is offset by a gain on the underlying exposure, but that gain is often unrealised, or arrives only later. So you can be hedged economically and still run out of cash. A long-dated exposure hedged with a stack of short-dated futures makes this worse.

The classic case is Metallgesellschaft (MGRM, 1993). The firm sold long-term fixed-price oil product contracts, up to about 10 years, and hedged them by buying short-dated oil futures, a stack and roll strategy. Oil prices fell, so it faced huge margin calls while the gains on the forward sales were spread over future years. The market was also in contango (futures above spot, so the near contract was cheaper than the far one), so a long hedger like MGRM loses on each roll when that spread persists. The parent company's supervisory board and management closed the positions, which crystallised the losses. The lesson is that a hedge can be sound on value yet fail on cash flow.

Accounting and tax also matter. A hedge may be treated for accounting purposes in a different way from the exposure. If the futures are marked to market but the hedged item is not, reported earnings become volatile. Hedge accounting rules let a qualifying hedge match the timing of gains and losses, but you need documentation and evidence that the hedge is effective. Tax can also treat hedge gains and losses differently from the underlying, so the after-tax result may differ from the pre-tax design.

Key formulas to remember

Hedge ratio with stack: N = (Exposure ÷ Contract size) × h; h is the hedge ratio (for minimum variance, h = ρ × σS ÷ σF). Stack and roll uses the full amount in the short contract, so N is often large.
Effective price after one roll: Effective price = S_T + (F0 − F_roll_close) + (F_roll_open − F_T_close), for a short hedger; S_T is the spot price at the end. F0 is the opening price of the old contract and F_roll_close is its closing price at the roll. F_roll_open is the price at which the new contract is sold and F_T_close is its closing price at the end. The first bracket is the old contract's gain per unit and the second bracket is the new contract's gain per unit.
Roll gain or loss (short hedge): Roll result = F(new, open) − F(old, close); Per unit, for a short hedger who closes the old contract and sells the new one. It is the spread realised at the roll, and it is not known in advance. Positive means the new contract is sold higher than the old one closed. For example, 77.50 − 76.00 = +1.50. Sign flips for a long hedger. Check the position first.
Variation margin cash flow: Daily cash flow = (Ft − Ft−1) × contract size × number of contracts; Sign depends on position: long receives when price rises; short pays when price rises.
Tailing the hedge: Tailed contracts = h × (VA ÷ VF) × 1 ÷ (1 + r)^T; VA is the value of the exposure and VF is the value of one futures contract. The tail is a discount factor, approximately 1 ÷ (1 + r)^T, where r is the interest rate and T the hedge horizon in years. It allows for daily settlement of futures. For positive rates it is below 1, so it reduces the number of contracts slightly.

How to solve Futures Pricing, Rolling and Hedge Accounting Issues questions

Use the same approach for any question on rolling hedges, liquidity risk or accounting treatment.

1Identify the exposure: its size, its date and whether you are long or short the underlying.
2Decide the hedge position: a short futures hedge for a long exposure, a long futures hedge for a short exposure.
3List each contract month and roll date. Note the futures price when each contract is closed and the next opened.
4Compute the futures P&L for each period, then the roll spread. Use the position's sign carefully.
5Add the futures results to the hedged item's result to get the effective outcome. Check what basis or roll risk remains.
6For liquidity questions, calculate the daily or cumulative margin cash flow and compare it with available funding. Remember the offsetting gain may not be cash yet.
7For accounting or tax questions, ask whether the hedge qualifies, how gains and losses are timed, and whether the hedged item is marked to market.
8Pick the answer that matches the economic logic: rolling reduces maturity mismatch but adds roll-over basis and funding risk.

Quickest way: Sign and cash-flow check

When to use it: Use it for numeric multiple-choice questions where several options differ mainly in sign or timing.

Write the position: long or short futures.
Price rises: long gains, short loses. Price falls: the opposite.
Total outcome = sum of futures P&L + result on the exposure. Do not forget the roll spread.
If the question asks about cash needs, count only the futures margin flows, not the unrealised gain on the exposure.
Eliminate options that confuse hedge ratio with number of contracts, or that mix up long and short.

Common mistakes in Futures Pricing, Rolling and Hedge Accounting Issues

Saying a stack and roll hedge removes all risk
Students focus on the matching of price exposure and forget the rolling.
Fix: State that it leaves roll-over basis risk and funding risk. Only the price level exposure is reduced.
Assuming the Metallgesellschaft loss was only a bad hedge
The headline losses on the futures look like a failed hedge.
Fix: Explain that the economic position may have been hedged, but the margin calls created a cash flow and liquidity problem, and management closed the hedge.
Getting the sign of the roll gain wrong
Long and short positions reverse the sign, and students apply the rule from memory.
Fix: Write the position, then compute the new contract's opening price minus the old contract's closing price for a short hedger, and reverse for a long hedger.
Ignoring that futures losses are paid in cash daily
Students treat the hedge as a single net position over its life.
Fix: Separate the daily futures cash flow from the exposure gain. Funding risk arises from the mismatch in timing.
Treating hedge accounting as automatic
Students assume any economic hedge gets matched treatment.
Fix: Remember that hedge accounting needs formal designation, documentation and effectiveness testing. Without it, derivative gains and losses go straight to earnings.

Worked examples

Example 1

A refiner must sell 100,000 barrels of oil in 6 months. It sells short-dated futures now at USD 80.00 and rolls into a 6-month contract after 3 months. At the roll, the near contract closes at USD 76.00 and the new contract is sold at USD 77.50. At the end, the new contract is closed at USD 74.00 and spot is USD 73.50. Ignore margin interest. What is the net realised price per barrel?

Show the solution

Position: the refiner is long the oil, so it is short futures.
First leg futures gain per barrel = 80.00 − 76.00 = USD 4.00.
Second leg futures gain per barrel = 77.50 − 74.00 = USD 3.50.
Total futures gain = 4.00 + 3.50 = USD 7.50.
Sell the oil at spot: USD 73.50.
Net price = 73.50 + 7.50 = USD 81.00 per barrel.

Answer: USD 81.00 per barrel, or USD 8,100,000 in total for 100,000 barrels. It decomposes as: initial futures price 80.00 + spread realised at the roll 1.50 + final basis (spot − futures) of 73.50 − 74.00 = −0.50, giving 80.00 + 1.50 − 0.50 = 81.00. The spread realised at the roll is 77.50 − 76.00 = +1.50, which favoured the short hedger in this case. It was not known in advance and could have been negative. The final basis of −0.50 is adverse for a short hedger because the futures close above spot.

Exam tips

Expect conceptual questions on Metallgesellschaft: the answer is usually funding liquidity risk from the stack and roll strategy, not just bad luck on prices.
Always check whether the question asks about total economic result or cash flow. They differ.
For roll gains and losses, write the position first. Most errors are sign errors.
Remember that rolling removes maturity mismatch but leaves roll-over basis risk.
On accounting questions, pick the answer that says hedge accounting needs designation, documentation and effectiveness testing.

Practice questions from Futures Markets

Futures Pricing, Rolling and Hedge Accounting Issues: frequently asked questions

What is a stack and roll hedge?

You place the whole hedge in short-dated contracts, which are the most liquid, and replace them as they expire. It matches the price exposure but leaves roll-over basis risk and funding risk. Metallgesellschaft used it for long-term oil commitments.

Why did Metallgesellschaft run into trouble?

Oil prices fell, so its long futures lost value and required large cash margin payments. The offsetting gains on its fixed-price contracts came much later. The firm also faced rolling costs in a contango market, and the position was closed, locking in losses.

What is liquidity risk in futures hedging?

It is the risk of being unable to meet daily margin calls. The hedge may be effective in value terms, but the cash needed arrives before the offsetting gain. A firm may then be forced to close the hedge early.

Do futures hedges always get hedge accounting treatment?

No. A hedge must be formally designated and documented, and it must be expected to be effective. Otherwise, gains and losses on the derivative go to earnings separately from the hedged item, which can make reported profit volatile.