Roll Return / Roll Yield

G

GetSetGo

New member
Joined
Jun 18, 2026
Messages
0
Reaction score
0
I am looking for intution behind Roll Return.
When we enter a futures contract, the no arbitrage contract price = risk free rate
Collateral Return = Risk Free Rate
If the Spot Price of the commodity representing the futures contract changes after the purchase of the Futures Contract, The change in Futures Price owing to change in Spot Price is Spot Return.
After entering the Futures contract, if the slope of the forward curve increase (due to change in future expectations, not expectations pertaining to spot prices ) this leads to a negative Roll Yield or Roll Return.
If the slope of the forward curve is negative (backwardation) than the Roll Return is positive.
Roll Return is a function of change in future expectations leading to a change in the terms tructure of the forward curve.
Is my understanding correct ?
 
I am not sure if this will help but its an interesting example of a real life scenario.
Say you own some pools of fixed rate agency MBS and say its 100m of Fannie 5.5 pools. As you might know agency MBS trades primarily in the futures market.
It is now February 19 and the current february MBS future expires on February 20th(next day). Anyone that is long a Feb Fannie 5.5 tba contract will have to roll there contracts to the March contract or will have to accept delivery of Fannie 5.5 pools (that’s what you own). To roll he would sell his current feb contract and buy the march.
So you also have a decision. If the Market is in “normal backwardization” then your futures prices are lower then the spot. This is known as the roll or drop.
So, we own pools (assume that these pools are deliverable) which will pay our fixed coupon plus whatever we earn or lose on the prepays over the month or March.
The other investor is long the Fannie 5.5 TBA (future contract) and needs to either roll his contract to the march contract or accept delivery of the pools to hold for the month.
So actually, despite the two different scenarios the two investors are in the same spot. The pool owner needs to decide if the drop or roll will return better then his pools. If he thinks that the drop is better then holding his pools he can short the Feb Fannie 5.5 contract which will expire tomorrow and deliver his pools. At the same instant he can buy the March Fannie 5.5 TBA and will now be able to earn the drop. The investor that is long the Feb Fannie 5.5 TBA could stay long the contract at expiry, accept the pools and hold them for the month thinking that they will carry better then the drop he will earn on rolling his future contract (ie selling his feb Fannie 5.5 tba to net his position and buying the march fannie 5.5 tba).
The normal backwardization assumes that the March future will increase in value. You need that to happen to earn the drop. You could also hedge the MV movements so you can try to earn that drop and offset any adverse movements.
 
Three components of commodity futures contract:
1) The Spot Return: The change in the futures contract that results from a change in the underlying commodity.
2) Collateral Return: a.k.a. collateral yield – comes from the assumption that the full value of the underlying futures contract is invested to earn the risk free rate. When an investor goes long a futures contract, he posts 100 percent margin in the form of T-bills. The contract is fully collateralized and the yield he gets is the collateral yield.
3) Roll Return: Roll yield results from rolling a long futures position forward through time. When a market is in backwardation (futures price is lower than the spot price), a positive return will be earned from a simple buy and hold strategy, This is b/c as the futures contract gets closer to maturity, the price must converge (contract price will go up) to that of the spot price of the commodity. When you roll it forward to the next month, you are buying a new contract at a price that is lower than the spot price.
Roll Yield = Futures Price at Montht – 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).
**The larger the convenience yield (the non-monetary benefit of holding a commodity) the higher the roll returns. Why? The futures price will be higher today than in the future because the holder is giving up the convenience yield associated over that time period. Hence, the market would be in backwardation and offer a roll yield**
 
one other interpretation:
the returns to investor(long) depends on the difference between futures strike price (X) and and the underlying commodity sale price (S) on the expiry date:
That means.. higher the range of (s-x), higher the yield to investor.
Now, this is possible in two ways;
1) with the increase in S wrt X.. this is called price return.
2) with the decrease in X wrt S.. this is called roll yield (which is possible in markets with backwardation)
 
jbisback Wrote:
Jb I think your last statement should say futures price now is less than it will be in the future.
—————————————————-
> Three components of commodity futures contract:
> 1) The Spot Return: The change in the futures
> contract that results from a change in the
> underlying commodity.
> 2) Collateral Return: a.k.a. collateral yield –
> comes from the assumption that the full value of
> the underlying futures contract is invested to
> earn the risk free rate. When an investor goes
> long a futures contract, he posts 100 percent
> margin in the form of T-bills. The contract is
> fully collateralized and the yield he gets is the
> collateral yield
> 3) Roll Return: Roll yield results from rolling a
> long futures position forward through time. When a
> market is in backwardation (futures price is lower
> than the spot price), a positive return will be
> earned from a simple buy and hold strategy, This
> is b/c as the futures contract gets closer to
> maturity, the price must converge (contract price
> will go up) to that of the spot price of the
> commodity. When you roll it forward to the next
> month, you are buying a new contract at a price
> that is lower than the spot price.
>
> Roll Yield = Futures Price at Montht – 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).
>
> **The larger the convenience yield (the
> non-monetary benefit of holding a commodity) the
> higher the roll returns. Why? The futures price
> will be higher today than in the future because
> the holder is giving up the convenience yield
> associated over that time period. Hence, the
> market would be in backwardation and offer a roll
> yield**
 
A key thing to remember is that at contract expiration, the spot and forward price must converge.
Say on December 1 the spot price is $100 and you are looking at a downward sloping futures curve (backwardation). You purchase the January contract at say $90, and over the course of the next month the spot price does not move - stays at $100. By the time your January contract expires, its price must converge to the spot sprice of $100, so on expiration day, you can sell the contract you purchased at $90 for $100, and this is a positive roll return.
Imagine the same scenario occurs but you are looking at an upward sloping futures curve (contango). This is why the roll yield is negative in contangoed markets, since you buy high and sell low.
 
I have to spend some more time on this, it confuses the hell out of me,.
 
You must log in or register to reply here.
Back
Top