What it means
Futures contracts expire, so anyone wanting continuous exposure to oil, wheat or natural gas must close the near contract and buy a later one. That swap is called rolling, and whether it costs or earns money depends entirely on the shape of the futures curve.
When later contracts are more expensive than nearer ones, the market is in contango, and each roll means selling low and buying high, producing negative roll yield. When later contracts are cheaper, the market is in backwardation, and each roll sells high and buys low, producing positive roll yield.
This matters to businesses that hedge commodity costs just as much as to investors. A haulage firm hedging diesel for a year is not paying the spot price; it is paying the curve, and a steep contango raises the true cost of that protection well above what the pump price suggests.
The most common confusion is between the spot price and the return on a futures position. An exchange traded fund tracking oil can report a double digit annual loss while spot oil is flat, simply because twelve monthly rolls in contango have shaved value off the position each time.
Positive roll yield is not free money either. Backwardation usually reflects a genuine physical shortage, and the gain from rolling is the compensation investors receive for holding a position that can reverse sharply once supply recovers.
In practice
Real-world examples.
Example
A pension fund allocating to commodities as an inflation hedge discovers its index tracker returned -9% in a year when the underlying commodity basket rose 3%. The entire shortfall came from rolling contracts in a persistently contangoed market.
Example
An airline hedging jet fuel eighteen months forward finds the far dated contracts trade well above spot. Its treasurer reports the hedge cost to the board as the premium over spot rather than as a simple fuel price, so the true expense of certainty is visible.
Example
A commodity trading firm deliberately builds positions in backwardated markets, earning a positive roll each month even when prices are flat. The strategy works for two years and then reverses when a supply glut flips the curve into contango.
Think of it
“Roll yield is what you gain or lose when rolling to the next futures contract.
Formula
Calculation
Roll yield per roll = (price of expiring contract - price of new contract) / price of expiring contract
A fund holds $8,000,000 of crude oil futures. The expiring contract trades at $80 a barrel and the next month trades at $82, so the roll yield is ($80 - $82) / $80 = -2.5% for that single roll.
If the curve keeps that shape and the spot price never moves, six monthly rolls compound to (1 - 0.025) raised to the power of 6, minus 1, which equals -14.1%. The $8,000,000 position falls to roughly $6,873,000 even though oil finished the period exactly where it started.
Reverse the curve and the arithmetic reverses with it. With the expiring contract at $80 and the next month at $78, the roll yield is ($80 - $78) / $80 = +2.5%, and six such rolls would lift the same position to about $9,278,000 on an unchanged spot price.Case study
Seen in the real world.
This is an illustrative and entirely fictional example. Northbank Pension Trust, an invented scheme, put $60,000,000 into a front-month commodity index fund in the belief that it would track commodity prices closely. The trustees reviewed the mandate annually and looked mainly at the spot price index.
Over four fictional years the underlying commodity basket rose about 8% in total, yet the fund returned -11%. The consultant's report identified persistent contango as the cause, with monthly rolls costing an average of 0.4% and compounding to roughly 17.5% of drag over the period.
Northbank switched to a mandate that spread positions across the curve rather than always holding the front month, accepting slightly less sensitivity to spot moves in exchange for a much smaller roll cost. The illustrative point is that the headline commodity price and an investor's actual return can diverge for years.
Watch out
Common mistakes.
- Assuming a commodity fund's return will match the change in the commodity's spot price over the same period.
- Describing roll yield as a genuine income stream, when it is a structural feature of the futures curve rather than a payment anyone makes.
- Comparing hedging quotes from different providers on price alone without checking which contract months each is using.
Questions
People also ask.
Does roll yield apply to shares or bonds?
Not in this form, since only derivative positions with fixed expiry dates need rolling, though similar effects appear in rolled currency forwards and index futures.
Is contango always bad for an investor?
For a long futures position, yes, it creates a drag, but a producer selling forward into a contangoed curve receives more than the spot price.
How can an investor reduce roll costs?
By holding contracts further along the curve, spreading positions across several months, or using a fund that selects the roll date rather than always trading the front month.
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