Roll Yield

[JamesL11]

Hello,
The formula for Roll yield is:
Roll yield = spot price - futures price.
How can a yield be the difference between two price? If spot price = $50 and futures price = $48, then Roll yield =$2?
I thought a yield is in %.
Appreciate your helps

 

[bfry]

Typically when you talk yields you talk percentages. Yes.
However this is addressing something different. Roll Yield is the difference between the spot price and the futures price that you recieve when entering a futures contract and holding it until expiry. Remember that futures and spot prices converge at expiry. Therefore if futures markets are in contango (futures prices above spot prices) there is negative roll yield. The inverse is true with markets in normal backwardation.

 

[Research Analyst]

Isn’t roll yield a very rare source of future returns? And theoretically it’s understood that roll yield gives you return in the backwardation but practically how could this concept give a positive return?
Could anybody explain with an example?
Thanks

 

[Topperharley]

Research Analyst wrote:Isn’t roll yield a very rare source of future returns? And theoretically it’s understood that roll yield gives you return in the backwardation but practically how could this concept give a positive return? Could anybody explain with an example? Thanks

Buy low, sell high! In backwardation, futures is lower than spot so if you buy the futures contract, the price rolls up the curve and ends up at the spot price when it expires. There’s you’re profit, the difference between what you locked in on the futures contract versus the higher spot price that you can then sell the commodity at.
This, of course, assumes that the spot price remains constant which is a quite unlikely scenario.

 

[Research Analyst]

Thank you, also is roll yield with reference to rolling specifically (of the futures contract) coz contango is said to be negative roll yield… So that is negative because of the additional amount paid due to roll over?
Want to make sure if my understanding is correct..

 

[Topperharley]

Research Analyst wrote:Thank you, also is roll yield with reference to rolling specifically (of the futures contract) coz contango is said to be negative roll yield… So that is negative because of the additional amount paid due to roll over? Want to make sure if my understanding is correct..

In contango, the roll yield is negative (assuming you go long futures) because futures prices are higher than the spot. So, if you go long futures and hold the contract till expiration when the you roll down the curve and end up with a commodity worth less than what you paid for it. Of course, buying high and selling low equals negative yield.
It’s all about the shape of the futures curve (contango or backwardation) and whether you’re going long or short the futures contract. Those two pieces determine whether you have positive or negative roll yield.

 

[Research Analyst]

Oh alright… Now since you said whether you’re going long or short decides your positive or negative roll yield, if we go short on futures, in case of contango, we will get a positive roll yield, as we are selling high and buying low. But according to the shape it is a negative roll yield…