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Roll Yield



Definition

Roll yield refers to the amount gained or lost due to the price difference between expiring futures contracts and the forthcoming contract, while maintaining a position in an asset. It is significant in the commodities markets where futures contracts have different prices based on delivery dates. A positive roll yield occurs when the futures price is lower than the spot price, and a negative roll yield occurs when the futures price is higher.

Phonetic

The phonetics of the keyword “Roll Yield” is /roʊl ji:ld/.

Key Takeaways

  1. Definition: Roll Yield is a concept related to the futures market. It can either add to or reduce the returns of a futures contract. It is essentially the income generated from selling a futures contract that is about to expire and buying another contract with a later expiration date.
  2. Impact on Return: The roll yield could be positive or negative. A positive roll yield occurs when the futures market is in backwardation (when futures contracts are trading at a discount to the spot price). A negative roll yield occurs when the market is in contango (when futures contracts are trading at a premium to the spot price). The roll yield becomes part of the total return from the futures contract along with any change in the spot price.
  3. Significance: Understanding roll yield is vital because it allows an investor or trader to better understand the profit or loss potential when trading futures contracts. It is also an essential factor to consider when managing a portfolio of futures contracts, as it contributes to the performance of a commodity futures investment strategy.

Importance

Roll yield is crucial in the fields of business and finance as it’s a key component in the returns of a futures contract. This term refers to the return generated when a futures contract is rolled over from one expiration date to another with a lower price, resulting in profit for the investor due to the price difference. Understanding roll yield is important because it allows investors and financial analysts to accurately predict and evaluate the potential returns and risks associated with different futures contracts. Its importance is particularly observed in commodity markets where price changes can be significant, affecting the overall return on investment. Therefore, a comprehensive understanding of roll yield contributes to making informed investment decisions and maximizing returns.

Explanation

Roll yield is an essential component in the futures market that can significantly contribute to the returns made by commodities investors. It comes into play when an investor owns a futures contract, and the expiration date is approaching. Such an investor can ‘roll’ the contract to the next future expiration to avoid the physical delivery of the commodity. This process can result in either gain or loss, depending on the pricing situation of the futures market, commonly referred to as ‘roll yield’. The primary purpose of roll yield is to quantify or evaluate a potential gain or loss an investor can experience during this process. It is particularly beneficial in various market scenarios. For instance, in a contango situation, where the futures prices are higher than the spot prices, the roll yield would be negative as investors would be buying higher-priced contracts. Conversely, in a backwardation scenario, when futures prices are lower than the spot prices, investors experience a positive roll yield, as they are selling high and buying low. Thus, understanding and calculating roll yield can greatly influence an investor’s decision-making process in commodities trading.

Examples

1. Commodity Futures: Roll yield can be observed in the commodity market, where investors make use of futures contracts. For example, if an investor has a futures contract to buy oil at $100 per barrel in February and the March futures contract is priced at $90, the investor could potentially earn a positive roll yield by selling the February contract and buying the more inexpensive March contract. The difference in price would generate a roll yield of $10.2. Currency Trading: Another example of roll yield can be seen in foreign exchange markets. Investors holding a currency futures contract might decide to roll over their position as the contract nears its expiry. If the future contracts for the forthcoming month are priced lower than the current contract, the investor could profit from the positive roll yield.3. Treasury Futures: An investment firm may purchase treasury futures that expire three months from now. Assume the treasury futures are trading at a lower price six months into the future. As the firm’s futures contract nears expiry, it may sell the three-month contract and buy the six-month contract. The difference between the selling price and buying price is the firm’s roll yield. Although it might seem small for each contract, when dealing with hundreds or thousands of treasury futures contracts, the roll yield can become significant.

Frequently Asked Questions(FAQ)

What is roll yield?

Roll yield refers to the return gained or lost due to the process of rolling a futures contract forward. It occurs when the price of a futures contract converges to the spot price as expiry approaches.

How is roll yield calculated?

Roll yield can be calculated by subtracting the future spot price from the current futures price. If the result is positive, it represents a positive roll yield, and if the result is negative, it indicates a negative roll yield.

What does a positive roll yield indicate?

A positive roll yield occurs in the context of a backwardation market, where futures prices are lower than the spot price. It indicates potential profits when the futures contract is rolled forward.

What does a negative roll yield mean?

A negative roll yield occurs in contango market situations where futures prices are higher than the spot price. It indicates potential losses when the futures contract is rolled forward.

How does roll yield affect total return on futures contracts?

Roll yield forms one of three components that affect the total return on futures contracts – the other two being the spot rate of return and collateral yield. It can either increase or decrease the total return depending on whether it is positive or negative.

Can roll yield be used as an investment strategy?

Yes, trading strategies can be based on roll yield. For instance, in commodities markets, investors may prefer to invest in futures that display backwardation (positive roll yield) as they may gain when they roll over contracts.

Can the roll yield be controlled by traders or investors?

No, roll yield is governed by market dynamics and can’t be directly controlled by traders or investors. However, they can choose contracts and strategies that might benefit from expected roll yield scenarios.

What is the relation between roll yield and commodity futures contracts?

The concept of roll yield is particularly relevant in the context of commodity futures contracts, where holders often roll over their contracts instead of taking physical delivery of the commodity. Roll yield, hence, represents the costs or gains associated with this roll-over process.

Related Finance Terms

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