Tim Olson
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52 lines
2.9 KiB
Markdown
52 lines
2.9 KiB
Markdown
---
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description: "Commodity futures roll-yield strategy that goes long backwardated and short contangoed futures based on the ratio of front-month to second-month prices."
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tags: [commodities, futures, roll-yield, term-structure, carry]
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---
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# Roll Yields
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**Section**: 9.1 | **Asset Class**: Commodities | **Type**: Carry / Term Structure
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## Overview
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When commodity futures are in backwardation (downward-sloping term structure), long futures positions generate positive roll yield because as contracts approach expiry they roll up toward the higher spot price. In contango (upward-sloping term structure), the roll yield is negative. A zero-cost long-short portfolio can be constructed by going long commodities in backwardation and short those in contango.
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## Construction / Mechanics
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Define the backwardation/contango ratio for each commodity:
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```
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φ = P₁ / P₂ (454)
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```
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where P₁ is the front-month futures price and P₂ is the second-month futures price.
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- φ > 1: backwardation (front-month > second-month); long futures position earns positive roll yield
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- φ < 1: contango (front-month < second-month); short futures position earns positive roll yield
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**Portfolio construction:**
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- Rank all N commodity futures by φ
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- Buy futures with higher values of φ (stronger backwardation)
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- Sell futures with lower values of φ (deeper contango)
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- Dollar-neutral (zero-cost) implementation
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Roll yield is realised when the near-expiry contract is sold (covered) and a longer-dated contract is purchased, or vice versa for short positions.
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## Return Profile
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Profits from the periodic rolling of positions: as a backwardated contract approaches expiry, its price converges upward to the spot, generating a positive roll return. In contango the opposite holds and short positions benefit. Roll yield is distinct from spot price returns.
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## Key Parameters / Signals
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| Parameter | Description |
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|-----------|-------------|
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| φ = P₁/P₂ | Backwardation ratio; φ > 1 → backwardation, φ < 1 → contango |
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| Ranking quantile | Top/bottom quantile cut-off for long/short selection |
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| Roll frequency | Determined by contract expiry calendar |
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## Variations
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- Extend the ratio beyond the first two contracts to capture the broader term structure slope.
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- Combine with hedging pressure (Section 9.2) or momentum signals for a multi-factor commodity strategy.
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## Notes
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- Roll yields can be substantial in commodities with high storage costs (energy) or seasonal supply/demand patterns (agricultural).
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- The ratio φ is a snapshot measure; persistent backwardation or contango is more reliable than transient conditions.
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- Transaction costs from rolling (bid-ask spreads on each roll) must be weighed against the expected roll yield.
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- Convenience yield (the benefit of holding physical inventory) is the economic driver of backwardation in many commodity markets.
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