# Roll Yield: Definition, Strategy, Calculation & Example

Instructor: David Bartosiak

Dave draws off his years of experience as a Financial Advisor and Analyst to teach others all about finance and the investing world.

This lesson defines roll yield and other key concepts of futures contracts needed to fully understand the calculation including backwardation and contango.

## Rolling Out Futures Contracts

When trading futures contracts, traders have a choice between not only which instrument to trade but also which month to trade it in. The different months trade at different prices. Most of the time, futures markets are in contango. Contango occurs when the front month contract is cheaper than contracts dated further out.

For example, let's say January oil futures are trading at \$40, February oil futures are \$45 and March oil futures are \$50. Since each month's futures contract is trading lower than the month that follows, this market is said to be in contango.

The opposite of contango is backwardation. That's a really fancy way of saying that backwardation occurs when the front month contract is more expensive than contracts further out. Backwardation does not happen all that often because of several market forces. Among these forces is the opportunity for traders to capture what's known as roll yield.

Roll yield is the return a trader can get by rolling a shorter-term futures contract into a further out futures contract. In order to calculate roll yield, an investor needs to know the prices of the two futures contracts and the spot price of the underlying instrument.

Roll Yield = Change in futures price - change in the spot price

The spot price is the price where a financial instrument is currently trading at right now. Calculating the change in the futures price is as simple as comparing the short-term contract to the further out contract. When the market is in backwardation, the short-term contract is worth more than the further out contract. As long as the spot price doesn't change more than the difference in the futures contracts, roll yield will be positive. Futures contracts approach the spot price at expiration.

## Calculating Roll Yield

Assume June oil futures are trading at \$50, July oil futures are at \$45, and the spot price of oil is \$50 on the day of June expiration. Trader Bob decides to roll the June contract into the July contract. Fast-forward to the day of June expiration, and the spot price is still \$50. Trader Bob's roll yield would be:

Change in futures price = \$50 - \$45 = \$5

Change in spot price = \$50 - \$50 = \$0

Roll yield = \$5 - \$0 = \$5

Trader Bob, expecting the price of oil to remain the same or go up, took advantage of the positive yield roll. If Bob expected oil prices to drop, he would have avoided rolling out the contract and instead just taken his profits on the June contract and moved on.

It's important to note that roll yield can either be negative or positive. Positive roll yield occurs when markets are in backwardation. Negative roll yield happens during markets that are in contango.

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