What Is Roll Yield?
Roll yield is the amount of return generated in the futures market after an investor rolls a short-term contract into a longer-term contract and profits from the convergence of the futures price toward a higher spot or cash price.Roll yield is positive when a futures market is in backwardation, which occurs when a futures contract trades at a higher price as it approaches expiration, compared to when the contract is further away from expiration.
Key Takeaways
- Roll yield is the return from adjusting a futures position from one futures contract to a longer-dated contract.
- Positive roll yield exists when a futures market is in backwardation, which occurs when the short-term contracts trade at a premium to longer-dated contracts.
- When the market is in contango, the longer-term contracts are more expensive than short-term contracts and roll yield will be negative.
Understanding Roll Yield
Roll yield is a profit that can be generated when investing in the futures marketdue to the price difference between futures contracts with different expiration dates. When investors purchase futures, they have both the right and the obligation to buy the asset underlying the futures investment at a specified date in the future, unless they sell their position (to offset the long futures position) ahead of the delivery date.
Most futures investors do not want to take delivery of the physical asset that the futures investment represents, so they close the position before expiration or roll their near-term expiring futures investments into other futures contracts with expiration dates further in the future. Rolling the position allows the investor to maintain their investments in the assets without having to take physical delivery.
29.3 billion
The number of futures contracts traded worldwide in 2022.
Backwardation vs. Contango
When the market is in backwardation,the future price of an asset is below the expected cash or spot price. In this case, an investor profits when the position is rolled to the contract with a later expiration date because the investor is effectively paying less money than expected by the spot market for the underlying asset that the futures investment represents.
For example, imagine that an investor holds 100 crude oil contracts and wants to buy 100 again for expiration at a later date. If the contract's future price is below the spot price, the investor is actually rolling into the same quantity of an asset for a lower price.
Negative roll yield occurs when a market is in contango, which is the opposite of backwardation. When a market is in contango, the future price of the asset is above the expected future spot price, and so the investor will lose money when rolling contracts.
Returning to the example of an investor with 100 oil contracts, if the investor wants to roll into 100 oil contracts with a later expiration date as the contract nears expiration, the investor will pay more money for the oil contracts compared to the spot market. They would, therefore, have to pay more money to maintain the same number of contracts. Negative roll yieldshave sometimes led to significant losses by hedge funds and exchange traded funds that hold futures.
What Does It Mean to Roll a Futures Contract?
Rolling is the practice of renewing a futures contract beyond its original expiration date, allowing the contract holder to benefit from anticipated changes in the market price. In order to roll a contract, traders must first settle the gain or loss of the original contract.
How Do You Calculate Roll Yield for Futures Contracts?
Roll yield is essentially the opportunity to gain profits by buying long-term futures contracts and selling short-term ones. It is calculated based on the difference in price between two futures contracts, and the spot price of the underlying commodity. It is calculated by the formula (total change in futures prices) - (total change in spot price) = roll yield.
How Much Does It Cost to Roll Futures?
Futures traders can roll their contracts by selling their near-term contracts and buying new contracts with later expiration dates. The cost is equal to the difference between the two contract prices, plus trading and commission fees.
The Bottom Line
Roll yield represents the potential profits from extending a futures contract to a later expiration date, to take advantage of anticipated changes in the underlying commodity. Roll yield is positive when the future price is expected to increase, and negative when the market expects future price to decrease.
FAQs
Roll yield is the return from adjusting a futures position from one futures contract to a longer-dated contract. Positive roll yield exists when a futures market is in backwardation, which occurs when the short-term contracts trade at a premium to longer-dated contracts.
How to calculate roll yield? ›
In order to calculate roll yield, one needs two futures prices to compare and the current spot price. Spot price is the current market price for any investment asset. With this information, the roll yield formula is as follows: total change in futures price - total change in spot price = Roll yield.
What is roll yield in CFA Level 2? ›
Roll Yield = Futures Price at Month (t) – Futures Price at Montht-1 – Change in spot price The opposite is true when there is an upward sloping term structure of futures prices (i.e. the market is in contango and the futures price is higher than the spot price).
What is roll yield in hedging currency? ›
Buying currency forward at a discount leaves some room for the currency to appreciate and provide a positive roll yield. This will help returns, and it makes it easier to hedge the currency. So more asset managers will hedge currency risk when the forward points are priced to help their exposure.
What is a roll yield example? ›
Investor X expected the rates of soybean to either remain the same or increase. Therefore, she decided to roll the contract up to July, but on the date of the expiration, the spot price remains the same ($100). Investor X's roll yield would be as follows: Change in the Future's Price = $100 – $95 = $5.
What is positive roll? ›
Longitudinal axis (roll)
A positive rolling motion lifts the left wing and lowers the right wing. The pilot rolls by increasing the lift on one wing and decreasing it on the other.
What is the role of the roll yield? ›
– The roll yield represents the net benefit or cost of owning the underlying asset beyond moves in the spot price itself. Therefore, the spot return and roll yield together comprise the total return experienced by an investor (net of financing costs).
What is yield and how is it calculated? ›
How is yield calculated? Yield is calculated by dividing the income derived from the ownership of an asset over a certain time period—often a year—by the value or purchase price of that asset. Let's take a look at how to calculate the yield of a few different types of assets.
What is roll yield loss? ›
The roll yield is the difference between the profit or loss of a futures contract and the change in the spot price of the underlying asset of that futures contract.
What is roll yield risk? ›
Roll yield or rollover yield refers to the profit or loss resulting from rolling over options contracts or futures from one expiration to another. Most traders use it as a tool for risk management and portfolio performance optimization.
For the second level of the CFA, you will need a score of at least 65% to have a good chance of passing, although from year to year any score under 70% can be a pass or fail based on that year's weighted scoring.
What is the difference between carry and roll yield? ›
Carry for a certain horizon is equal to the certain payment(s) encountered over that period, i.e. payments known at the current time. Roll for a certain horizon is equal to the value appreciated simply by letting time elapse, i.e. it is the “return” stemming from a future curve being equal to today's curve.
What is roll yield and convenience yield? ›
Convenience yield is the benefit you get from holding an asset instead of simply holding a forward on that asset. Roll yield is the amount you make when you roll one (expiring) forward contract into another forward contract.
What is the difference between price return and roll return? ›
Price return is produced by a change in spot prices. Roll return is produced by closing expiring contracts and reestablishing the position in far-dated contracts. Roll return is sector dependent, it is positive when futures markets are in backwardation and negative when futures markets are in contango.
How to profit from backwardation? ›
Backwardation can occur as a result of a higher demand for an asset currently than the contracts maturing in the coming months through the futures market. Traders use backwardation to make a profit by selling short at the current price and buying at the lower futures price.
What does roll down yield mean? ›
Rolling down the yield curve is when investors sell bonds before their maturity date, in order to get a higher profit. This is a fixed income strategy that investors use in a low interest rate environment. The strategy gets its name from the fact that investors are selling bonds when the yield is lower.
What is the difference between roll yield and convenience yield? ›
Convenience yield is the benefit you get from holding an asset instead of simply holding a forward on that asset. Roll yield is the amount you make when you roll one (expiring) forward contract into another forward contract.
What is the difference between basis and roll yield? ›
Roll yield is the profit or loss that results from rolling over a futures contract from one month to the next. Basis trading, on the other hand, is the practice of buying or selling an asset in one market and simultaneously selling or buying the same asset in another market to take advantage of price discrepancies.
