Roll Yield

What is Roll Yield?

Roll yield is a type of return in commodity futures investing. It is driven by the difference in the price of shorter-dated, closer to maturity commodity contracts and their longer-dated counterparts.

A futures contract is a promise to either buy or sell a commodity in the future but at a pre-determined price or forward price. The real market value at which an instrument or asset is traded on the date of expiry or execution of the contract is called the spot price.

Roll yields can be either positive or negative, depending upon whether the market is in contango or backwardation. It is important to note that the roll return is only one of the multiple sources of return for commodity futures.

Roll return offers the added advantage of providing an insight into the expected price movement of a commodity futures contract, be it a drop in prices from contango, which is the opposite in case of backwardation. Thus, normal contango and normal backwardation refer to a phenomenon that cannot be observed or proved in real-time.

What is Contango?

When the prices of longer-dated contracts are higher than that of shorter-dated contracts, the market is said to be in contango. Contango occurs due to costs incurred by the commodity owner for holding or storing a particular commodity.

An investor looking to invest in the commodity will select a particular contract to purchase. In such a case, they will select a longer-dated contract. From a roll yield perspective, as time passes, the price of a contract will fall or roll down towards that of the next nearest contract. It, in turn, will fall lower towards the price of the nearest contract, and so on.

The process is called roll yield, and in the case of contango, the return is negative due to falling prices. In such a case, the investor will choose to sell the current contract or wait for it to expire to maintain commodity exposure in the future. They will then reinvest in a longer-dated contract, thus repeating the cycle.

What is Backwardation?

When the prices of longer-dated contracts are lower than that of shorter-dated contracts, the market is said to be in backwardation. It can happen in cases when the current inventory of a commodity is low.

For example, drought or excessive rainfall can cause poor agricultural harvest. In such cases, commodities for the current season would be in short supply, making contracts related to this year’s harvest to skyrocket. The price of the longer-dated contract would roll up to the next nearest contract, as a typical investor buying at market price would sell the contract at a slightly higher price. It is how investors earn a positive roll yield.

Calculating Roll Yield

In order to calculate roll yield, an investor needs to know the rates of the two futures contracts and the spot price of the underlying asset, which in this case, is a commodity. For example, assume that June soybean futures are trading at $100, while in July, they are trading at $95, the spot price being $100.

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
• Change in the Spot Price = $100 – $100 = $0
• Roll Yield = $5 – $0 = $5

Additional Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)® certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Contango vs Backwardation
• Expiration Date
• Forward Commitments
• Trading Mechanisms
• See all wealth management resources