Roll Yield is an important concept in futures trading that can significantly impact the returns of investors who hold positions through contract expiration dates. Simply put, roll yield refers to the gain or loss that arises when a trader rolls over a futures contract—closing out a near-expiry contract and opening a new contract with a later expiration date. Understanding roll yield is crucial for traders and investors using futures-based strategies, such as those in commodities, indices, currencies, or other asset classes.

When futures contracts approach their expiration, traders must decide whether to settle or roll their positions forward to maintain exposure. Rolling involves selling the current contract and buying the next one in the futures curve. The difference in price between these two contracts determines the roll yield. If the new contract is cheaper than the expiring one, the trader benefits from a positive roll yield (a gain). Conversely, if the new contract is more expensive, the trader experiences a negative roll yield (a loss).

The roll yield can be expressed as:

Formula: Roll Yield = Price of Near Contract – Price of Next Contract

This price difference is often influenced by the market’s expectations of future supply and demand, carrying costs (like storage and interest rates), and market sentiment. Two common futures curve shapes affect roll yield outcomes: contango and backwardation.

In a contango market, futures prices increase with longer maturities, meaning the next contract is priced higher than the near contract. Rolling over in contango results in a negative roll yield, as you are effectively “buying high and selling low” when transitioning contracts. For example, in oil futures markets during periods of oversupply, the curve often shows contango, leading to roll losses for long-term holders.

In contrast, backwardation occurs when futures prices decrease with longer maturities, so the next contract is cheaper than the near contract. Rolling in backwardation results in a positive roll yield or gain. This often happens when the market expects supply shortages or increased demand in the short term, as seen occasionally in natural gas or certain equity indices futures.

A practical example can clarify this. Suppose a trader holds a long position in the S&P 500 futures contract expiring in June, priced at 4,200. As expiration nears, the trader rolls into the September contract priced at 4,180. The roll yield here is 4,200 – 4,180 = +20 points, representing a positive roll yield. This gain offsets some of the costs associated with holding the position over time. However, if the September contract were priced at 4,220, the roll yield would be negative (-20 points), implying a cost to maintaining the position.

Common misconceptions about roll yield include confusing it with the overall return of a futures position. Roll yield is just one component of total returns, alongside spot price changes and any income from carrying the underlying asset (like dividends or storage costs). Another mistake is assuming roll yield is always positive or negative; it changes with market conditions and the shape of the futures curve.

Traders often ask, “How does roll yield affect ETFs or funds investing in futures?” Many commodity ETFs, such as oil or gold ETFs, hold futures contracts and must roll them regularly. In contango markets, these funds may suffer persistent roll yield losses, reducing returns relative to spot price movements. Understanding roll yield helps explain why such ETFs sometimes underperform the spot commodity price.

Another frequent query is, “Can roll yield be predicted?” While traders analyze futures curves and market fundamentals to anticipate roll yield, it is inherently uncertain, as it depends on changing supply, demand, and market sentiment.

In summary, roll yield is a vital factor influencing futures trading outcomes. It arises from the price difference between expiring and new contracts when rolling positions forward. Recognizing whether a market is in contango or backwardation helps traders anticipate potential roll yield impacts. Being mindful of roll yield can improve trading strategy design and risk management, particularly for those using futures-based instruments or related ETFs.