Roll yield
Encyclopedia
The roll yield is the yield
that a futures
investor captures when their futures contract converges to the spot price
; in a backwardated
futures market the price rolls up to the spot price, so the roll yield is positive, whereas when the market is in contango
the price rolls down to the spot price, so the roll yield is negative. The spot price can stay constant, but the investor will still earn returns from buying discounted futures contracts, which continuously roll up to the constant spot price.
For example, suppose the spot price of oil
is $58 and the market is inverted because inventories are relatively low. This means the first futures price might be at $57 and the next contract at $56. You go long
the front contract as described above. Now suppose a few weeks pass and nothing happens to the spot price. The futures contract you own moves toward the spot price as delivery approaches, and we can assume the spread
between the futures stays at a dollar. You sell your maturing futures near the $58 spot price and buy the next future for around $57. Note that in an inverted market you make money from the roll yield even if commodity prices remain unchanged.
Roll yield can have a strong impact on the return of futures trading. The contango exhibited in Crude Oil in 2009 explains the discrepancy between the headline spot price increase (bottoming at $35 and topping $80 in the year) and the various tradeable instruments for Crude Oil (such as rolled contracts or longer-dated futures contracts) showing a much lower price increase, because of the strong negative roll yield. The USO ETF (using futures contracts) also failed to replicate Crude Oil's spot price performance.
Yield (finance)
In finance, the term yield describes the amount in cash that returns to the owners of a security. Normally it does not include the price variations, at the difference of the total return...
that a futures
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...
investor captures when their futures contract converges to the spot price
Spot price
The spot price or spot rate of a commodity, a security or a currency is the price that is quoted for immediate settlement . Spot settlement is normally one or two business days from trade date...
; in a backwardated
Backwardation
Normal backwardation, also sometimes called backwardation, is the market condition wherein the price of a forward or futures contract is trading below the expected spot price at contract maturity. The resulting futures or forward curve would typically be downward sloping , since contracts for...
futures market the price rolls up to the spot price, so the roll yield is positive, whereas when the market is in contango
Contango
Contango is the market condition wherein the price of a forward or futures contract is trading above the expected spot price at contract maturity. The resulting futures or forward curve would typically be upward sloping , since contracts for further dates would typically trade at even higher prices...
the price rolls down to the spot price, so the roll yield is negative. The spot price can stay constant, but the investor will still earn returns from buying discounted futures contracts, which continuously roll up to the constant spot price.
For example, suppose the spot price of oil
Oil
An oil is any substance that is liquid at ambient temperatures and does not mix with water but may mix with other oils and organic solvents. This general definition includes vegetable oils, volatile essential oils, petrochemical oils, and synthetic oils....
is $58 and the market is inverted because inventories are relatively low. This means the first futures price might be at $57 and the next contract at $56. You go long
Long (finance)
In finance, a long position in a security, such as a stock or a bond, or equivalently to be long in a security, means the holder of the position owns the security and will profit if the price of the security goes up. Going long is the more conventional practice of investing and is contrasted with...
the front contract as described above. Now suppose a few weeks pass and nothing happens to the spot price. The futures contract you own moves toward the spot price as delivery approaches, and we can assume the spread
Spread
Spread may refer to:*Statistical dispersion*Spread , an edible paste put on other foods*the score difference being wagered on in spread betting*the measure of line inclination in rational trigonometry...
between the futures stays at a dollar. You sell your maturing futures near the $58 spot price and buy the next future for around $57. Note that in an inverted market you make money from the roll yield even if commodity prices remain unchanged.
Roll yield can have a strong impact on the return of futures trading. The contango exhibited in Crude Oil in 2009 explains the discrepancy between the headline spot price increase (bottoming at $35 and topping $80 in the year) and the various tradeable instruments for Crude Oil (such as rolled contracts or longer-dated futures contracts) showing a much lower price increase, because of the strong negative roll yield. The USO ETF (using futures contracts) also failed to replicate Crude Oil's spot price performance.