To a forex trader, the term rollover generally refers to a change made to the value date of a forex transaction that is usually done to extend the settlement of the trade further out in time.
Rollovers are a very commonly used form of foreign exchange swap, and the most popular rollover is known to professional forex traders as a tom/next swap. This name arises because such traders usually roll out their positions traded the previous day that is now value Tom or tomorrow to the next available business day.
They do this rollover every morning so that all of their positions are value spot or two business days from the current day and can therefore net out at settlement. The lone exception to this value date rule for spot is USD/CAD that is typically traded as “funds” for value tomorrow or one business day from the dealing date.
Spot/next swaps are also sometimes used as rollovers when a trader rolls over their positions at the end of their trading day, rather than the following morning.
Why Forex Traders do Rollovers
Most speculative forex traders routinely perform rollovers each day as described above in order to avoid having their currency trading positions go to delivery, and this is especially true of those dealing on margin through an online forex broker.
In fact, those involved in forex trading online using margin will often have their trading positions automatically rolled over by their online forex broker. Such automatic rollovers usually occur if a position is left open at 5pm New York time that is considered the close of the global trading day by the forex market.
Nevertheless, those traders who are hedging cash flows in the forex market and therefore wish to actually take delivery of one currency in exchange for another will not be interested in doing rollovers, unless their original delivery date has changed for some reason.
Transaction Costs of Rolling Positions Over
Like a regular forex spot or forward transaction, a rollover has a bid offer spread associated with it that can result in an additional modest transaction cost to a forex trader who is dealing their rollovers through forex trading brokers.
Furthermore, in order to attract business from those interested in forex trading online, many top forex brokers that offer competitive rollover rates will advertize their rollover swaps for forex trades on their websites for each currency pair.
Rollover Costs and Credits
In addition to the rollover dealing spread, a trader can either earn points if they are long the higher interest rate currency at the time when the rollover is done, or they can pay away points if they are long the lower interest rate currency at that time.
The principle of interest rate parity is used to compute these rollover points, although supply and demand effects can also influence rollover costs. In general, the cost or credit associated with performing a rollover will depend largely on the interest rate differential between the two currencies in the currency pair being rolled over. The greater the interest rate differential is for a currency pair, the greater the rollover cost or credit will be.
These costs associated with rollovers are rarely important to day traders that generally close down all of their positions before the end of their trading day. On the other hand, carry traders thrive on exploiting the rollover and earning points each day from carrying their position in which they typically seek to borrow a low interest rate currency and lend out a higher interest rate currency over a significant period of time.