Key Characteristics of Roll Yield:

1. Futures Contracts:
   • Futures contracts are standardized agreements to buy or sell an asset (like commodities, financial instruments, or currencies) at a specified price on a future date. These contracts have expiration dates, after which they must be settled or rolled over to a new contract.
2. Contango and Backwardation:
   • Roll yield is influenced by the shape of the futures curve, which can be in contango or backwardation:
     • Contango: A market condition where the futures prices are higher than the spot price or the price of nearer-term contracts. Rolling contracts in a contango market often results in a negative roll yield, as investors sell the expiring contract at a lower price and buy the longer-term contract at a higher price.
     • Backwardation: A market condition where the futures prices are lower than the spot price or the price of nearer-term contracts. Rolling contracts in a backwardation market can result in a positive roll yield, as investors sell the expiring contract at a higher price and buy the longer-term contract at a lower price.
3. Positive vs. Negative Roll Yield:
   • Positive Roll Yield: Occurs in a backwardation scenario where the investor rolls into a cheaper contract while selling the expiring contract at a higher price, thereby generating a profit.
   • Negative Roll Yield: Occurs in a contango scenario where the investor has to buy a more expensive contract while selling the expiring one at a lower price, leading to a loss.
4. Importance in Commodity Investing:
   • Roll yield is particularly important in commodity investing where futures contracts are commonly used. Commodity funds or ETFs that track commodity futures may experience positive or negative roll yields depending on the market conditions.
5. Impact on Returns:
   • Roll yield can significantly impact the overall returns of a futures-based investment. Even if the spot price of the commodity remains unchanged, the act of rolling contracts in a contango market can lead to losses, while rolling in a backwardation market can lead to gains.

Example:

Suppose an investor holds a futures contract for crude oil that is about to expire. The current contract (near-term) is priced at $50 per barrel, and the next month’s contract (longer-term) is priced at $52 per barrel. The market is in contango. To maintain the position, the investor sells the expiring contract at $50 and buys the next contract at $52. The investor incurs a negative roll yield of $2 per barrel.

Conversely, if the futures curve were in backwardation, with the near-term contract priced at $52 and the next month’s contract priced at $50, the investor would gain a positive roll yield of $2 per barrel by rolling over the position.

Importance:

• Futures Trading Strategies: Understanding roll yield is crucial for traders and investors who use futures contracts, as it can affect the profitability of their strategies.
• Commodity Funds and ETFs: Investors in commodity-based funds or ETFs need to be aware of roll yield, as it can influence the performance of these investment products, especially in markets that are consistently in contango or backwardation.
• Risk Management: Roll yield considerations are essential in risk management, helping investors anticipate potential losses or gains when rolling over futures contracts.

Roll yield is the gain or loss generated when rolling a futures contract from one expiration date to another, influenced by the market conditions of contango or backwardation. It plays a significant role in the performance of futures-based investments, particularly in commodities.