Skip to main content
← Back to A Definitions

Adjusted roll yield

What Is Adjusted Roll Yield?

Adjusted roll yield is a refined measure within the field of Futures Trading that quantifies the profit or loss generated when an investor "rolls over" a futures contract. Rolling over involves closing an expiring futures contract and simultaneously opening a new contract for the same underlying asset with a later expiration date. While standard roll yield simply reflects the price difference between the expiring and new contract, adjusted roll yield accounts for additional factors such as storage costs, interest expenses, and other costs of holding the underlying asset. This adjustment provides a more comprehensive view of the yield component attributable to the futures curve's shape rather than purely spot price movements. It is a critical component in understanding the total return of a futures position, particularly in commodity markets where physical delivery and carrying costs are significant.

History and Origin

The concept of roll yield is intrinsically linked to the evolution of futures contracts themselves, which have been traded for centuries, initially for agricultural commodities to manage price risk. As organized exchanges developed, particularly in the 19th and 20th centuries, the practice of rolling over positions became common for traders and investors who sought continuous exposure to an asset without taking physical delivery. The observation that futures prices for different maturities did not always align with spot prices, leading to gains or losses upon rollover, gave rise to the term "roll yield."

The "adjusted" aspect of roll yield became more prominent with the increased sophistication of financial modeling and the recognition that the difference between futures and spot prices, often termed the "basis," is influenced by the cost of carry. The theory of storage helps explain why commodity futures prices might diverge from spot prices, attributing these differences to factors like storage costs, insurance, and the convenience yield of holding the physical commodity. For instance, during periods of significant market stress, such as the 2020 oil price crash, the oil market experienced extreme contango, leading to substantial negative roll yields for those holding long positions as storage concerns mounted and demand plummeted26, 27. This highlighted the importance of understanding the underlying drivers of futures prices beyond simple price differences. Academic research has further explored the impact of roll yield on returns; for example, a 2018 study found that, after adjusting for interest rates, roll yield constituted a significant portion of average returns for a long-run index of commodity futures over 140 years25.

Key Takeaways

  • Adjusted roll yield measures the profit or loss from rolling over futures contracts, considering costs like storage and interest.
  • It provides a more accurate picture of returns influenced by the futures curve's shape, specifically contango (negative adjusted roll yield) or backwardation (positive adjusted roll yield).
  • Understanding adjusted roll yield is crucial for investors in commodity and other futures-linked assets, including many Exchange-Traded Funds.
  • It is distinct from the underlying asset's price change and reflects a component of the total return on a futures position.

Formula and Calculation

Calculating adjusted roll yield involves considering the prices of the expiring futures contract and the new, longer-dated contract, along with the annualized cost of carrying the underlying asset. While a simplified roll yield is often calculated as the percentage difference between the far month and near month futures prices, the adjusted roll yield incorporates the cost of carry.

A basic form of roll yield can be expressed as:

Roll Yield=Price of Further-Out ContractPrice of Near-Month ContractPrice of Near-Month Contract\text{Roll Yield} = \frac{\text{Price of Further-Out Contract} - \text{Price of Near-Month Contract}}{\text{Price of Near-Month Contract}}

For a more precise adjusted roll yield, one would factor in the cost of carry (storage, insurance, financing costs, and any convenience yield). In an efficient market, the difference between the futures price and the spot price for a storable commodity should theoretically equal the cost of carry. Therefore, the adjusted roll yield essentially looks at the component of return (or loss) derived from the change in the basis that is not explained by these costs. This distinction helps separate true market-driven yield from expenses.

More broadly, roll yield can be understood as the difference between the futures return and the spot return of the underlying asset24. The adjusted roll yield refines this by accounting for specific carrying costs that drive part of that futures-spot divergence.

Interpreting the Adjusted Roll Yield

Interpreting the adjusted roll yield is fundamental for participants in futures markets. A positive adjusted roll yield indicates that the market is in backwardation, meaning the price of the near-term futures contract is higher than the price of the longer-term contract. In such a scenario, as the investor rolls their position forward, they are effectively selling the expiring contract at a higher price and buying the new contract at a lower price, potentially generating a positive return. This often suggests a tight supply or high demand for the immediate delivery of the commodity.

Conversely, a negative adjusted roll yield suggests a market in contango, where longer-term contracts are priced higher than near-term contracts. When rolling a position in a contango market, an investor sells the expiring contract at a lower price and buys the new one at a higher price, leading to a negative return component. Contango typically arises when there are costs associated with storing the commodity, such as for gold or oil, which are factored into the price of future contracts22, 23. Understanding these dynamics allows investors to adjust their investment strategies to either capitalize on positive adjusted roll yield or mitigate the impact of negative adjusted roll yield. It also provides insights into market structure and expectations for future supply and demand conditions.

Hypothetical Example

Consider an investor, Sarah, who holds a long position in a crude oil futures contract set to expire in one month. The current price of this expiring contract is $75.00 per barrel. To maintain her exposure to crude oil, Sarah decides to roll her position into a new contract that expires in two months. The price of this two-month contract is $76.50 per barrel.

A simple calculation of roll yield would show:

Roll Yield=$76.50$75.00$75.00=$1.50$75.00=0.02 or 2%\text{Roll Yield} = \frac{\$76.50 - \$75.00}{\$75.00} = \frac{\$1.50}{\$75.00} = 0.02 \text{ or } 2\%

This 2% represents a negative roll yield, as she is buying the next contract at a higher price. This indicates a contango market structure.

Now, let's consider the adjusted roll yield. Suppose the monthly storage cost for one barrel of crude oil is $0.50, and the financing cost (interest) associated with holding the value of the oil is $0.25 per barrel for that month. These combine for a total cost of carry of $0.75 per barrel for the one-month period.

The price difference of $1.50 per barrel between the contracts is partially explained by these carrying costs. The adjusted roll yield would essentially consider the portion of this $1.50 difference that is not covered by the $0.75 cost of carry. In this simplified scenario, if the futures price difference perfectly reflected the cost of carry, the "adjusted" roll yield (attributable purely to market expectations beyond carry costs) would be lower. For practical purposes, a negative roll yield implies that holding the position and rolling it forward costs money due to the market's contango structure and the associated carrying costs.

Practical Applications

Adjusted roll yield plays a significant role in various aspects of investment and market analysis. In commodity markets, it is a crucial driver of returns for investors holding long-term positions, especially those using exchange-traded products like ETFs that regularly roll futures contracts20, 21. A persistent negative adjusted roll yield in a contango market can erode returns, while a positive adjusted roll yield in a backwardated market can enhance them19.

For portfolio managers, understanding adjusted roll yield is vital for asset allocation decisions. It influences the attractiveness of commodities as an asset class and helps determine optimal exposure18. It also informs risk management strategies, as unanticipated shifts between contango and backwardation can significantly impact profitability17. Traders frequently use this concept when implementing calendar spreads, a strategy that aims to profit from the changing price differential between futures contracts of different maturities16. Furthermore, adjusted roll yield can offer insights into market expectations and market sentiment, with contango often signaling expectations of rising future prices or ample supply, and backwardation suggesting tight immediate supply or anticipated price declines14, 15. For example, the CME Group provides extensive research on how roll yield insights can be applied to inform carry strategies and trend-following strategies in futures markets13.

Limitations and Criticisms

Despite its utility, adjusted roll yield has certain limitations and faces criticisms. One major challenge is its inherent unpredictability, as it depends on future spot prices and dynamic market conditions that are subject to uncertainty12. While the concept provides valuable insights into the structure of futures prices, some argue that its direct application for generating profit is often misunderstood. A common misconception is that roll yield represents a guaranteed profit or loss generated solely on the day of the contract roll11. However, the gain or loss from roll yield actually accrues over the life of the trade as futures prices converge towards spot prices10.

Furthermore, the theoretical underpinnings of adjusted roll yield often assume market efficiency, which may not always hold true in real-world scenarios. Inefficient markets can lead to discrepancies that are not fully explained by the cost of carry9. For investors, focusing solely on capturing a positive adjusted roll yield can be misleading; the primary focus should remain on managing overall portfolio risk and the expected returns from price changes in individual futures contracts8. For instance, certain academic perspectives suggest that while roll yield can explain divergences between futures and spot returns, it does not necessarily represent an independent source of profit that can be consistently exploited through simple rolling strategies7.

Adjusted Roll Yield vs. Roll Yield

While closely related, adjusted roll yield offers a more nuanced perspective than basic roll yield. Simple roll yield quantifies the profit or loss from rolling over a futures contract by merely taking the difference between the price of the new, longer-dated contract and the expiring contract. It is a straightforward measure of the immediate cost or benefit of the rollover transaction itself.

Adjusted roll yield, however, goes a step further by incorporating the various costs and benefits associated with holding the underlying asset over time, primarily the cost of carry. These costs can include storage, insurance, and financing, offset by any convenience yield derived from holding the physical commodity. By considering these factors, adjusted roll yield aims to isolate the portion of the roll return that is truly attributable to the market's expectation of future supply and demand dynamics, beyond the direct expenses of holding the asset. This distinction is crucial for a more accurate assessment of a futures position's profitability and for disentangling the various components of a futures contract's return.

FAQs

What causes adjusted roll yield to be positive or negative?

Adjusted roll yield is positive when the futures market is in backwardation, meaning near-term contract prices are higher than longer-term contract prices. This allows investors to sell the expiring contract at a higher price and buy the next one at a lower price. Conversely, it is negative in contango markets, where longer-term contracts are more expensive, leading to a cost when rolling over positions due to factors like storage costs5, 6.

Is adjusted roll yield the same as futures profit?

No, adjusted roll yield is only one component of the total return from a futures position. The total profit or loss also depends on the change in the underlying asset's spot price during the holding period. Adjusted roll yield isolates the return generated specifically from the rolling process and the shape of the futures curve4.

How does adjusted roll yield impact commodity ETFs?

Many commodity Exchange-Traded Funds (ETFs) invest in futures contracts and must regularly roll their positions. A persistent negative adjusted roll yield (in contango) can lead to these ETFs underperforming the spot price of the underlying commodity, as the cost of rolling over contracts erodes returns. Conversely, a positive adjusted roll yield (in backwardation) can enhance ETF performance2, 3.

Can adjusted roll yield be predicted?

Predicting adjusted roll yield precisely is challenging due to its dependence on unpredictable factors like future spot prices, market sentiment, and evolving supply-demand dynamics. While historical patterns of contango and backwardation can offer some indications, its future value remains uncertain1.