Roll Yield

Published on :

21 Aug, 2024

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Roll yield or rollover yield refers to the profit or loss resulting from rolling over options contracts or futures from one expiration to another. Most traders use it as a tool for risk management and portfolio performance optimization. Moreover, it significantly impacts the overall returns on the investment of investors and traders who hold futures and options for a longer time.

Roll yield comes out to be different for futures contracts and options contracts. It can provide traders and investors with opportunities to enhance returns, manage risks, and gain insights into market trends. Furthermore, it does not give cash payments as profit, like dividend yields or fixed income. Nevertheless, it acts as a return envisaged by investors besides the changes in the price of underlying assets in a futures contract.

What Is Roll Yield?

Roll yield is the profit or loss when a trader rolls over a futures or options contract from one expiration date to another.
Many traders utilize rollover yield as a portfolio risk management and performance optimization technique.
To compute this, one must use the following equation: Roll Yield equals the overall alteration in futures price minus the general alteration in the spot price.
Depending on the differences between older and newer prices, it can be positive or negative. Backwardation is positive, while contango is negative due to carry cost.

Roll Yield Explained

Roll yield is the profit or loss that arises when an investor or trader holds a futures contract and rolls it over to a new contract with a later expiration date. Typically, investors who invest in commodity futures experience roll-yield commodities. Technically speaking, the rollover yield relates to the differences between the prices of the older and newer futures contracts or commodities.

Furthermore, the rollover yield that a trader gets depends entirely on the price movement direction of the future market plus its cost of carry.

Roll yield may be positive or negative in the following cases:

If the differences between the higher order price and the lower newer price are positive, then the rollover yield would be positive roll yield backwardation.
Suppose the differences between the cheaper older price and the expensive newer price are negative. In that case, the rollover yield is negative due to the occurrence of carrying a cost for the trader (termed as contango).

Rollover yield differs for futures contracts and options contracts as follows:

For futures contracts, it is the difference between the older expiring contract's future price and the underlying asset's spot price as compared to the newer contracts' future price being rolled over into.

Therefore, the rollover yield in an options contract refers to the variance between the implied volatility of the option approaching its expiration date and the implied volatility of the new option being rolled over. Thus, if the implied volatility of the expiring option is greater than the implied volatility of the new option, then this yield will be favorable. Conversely, if the implied volatility of the new option is higher, the rollover yield will be unfavorable.

Formula

For calculating roll yield futures, one needs to have the following data:

Price of the old futures contract
Cost of the new futures contract
Spot price at the Expiry date of the more senior futures contract
Spot price at the Expiry date of the newer futures contract

After obtaining the above data, one has to use the below formula to calculate the

Roll yield: the total change in futures price - A total change in spot price = (F2 - F1) - (S2 - S1)

Here in the formula, symbols represent the following:

F1= price of the older futures contract

F2= price of the newer futures contract

S1= spot price at the Expiry date of the older futures contract

S2= spot price at the Expiry date of the newer futures contract

It must be noted that the above formula gives the daily rollover yield. However, daily rollover is represented by expected loss or profits every day arising out of the price difference between the two contracts.

Graph

Let us look at the following roll yield graph to better understand the concept.

The above graph shows the returns achieved because of the futures price’s convergence toward the spot price of the asset as the futures contract nears the date of expiry. These returns refer to the roll yield.

Examples

Let us use a few examples to understand the topic.

Example # 1

Suppose, in the New York commodities exchange, the crude oil futures contract having a spot price of $105 gets traded:

In June = $105

In July = $85

Investor Jule expects the price of crude oil to either stay constant or increase. Hence, she decided to roll the crude oil futures contract up to July. But, the spot price of crude oil remains steady at $105 on its expiration date. Therefore, investor Jule's rollover yield would be:

F1= price of the older futures contract = $105

F2= price of the newer futures contract = $85

S1= spot price at the Expiry date of older futures contract = $105

S2= spot price at the Expiry date of newer futures contract = $105

Therefore, roll yield = total change in futures price - total change in spot price = (F2 - F1) - (S2 - S1)

= (105-85)-($105-$105)= $20

Example # 2

Suppose Alex has held on to an extended position of crude oil futures contract per barrel, expiring within one month. When the old contract nears its expiration, a new contract per barrel has to be made. Now

F1= price of the older oil futures contract per barrel = $60

F2= price of the newer oil futures contract per barrel = $65

S1= spot price at the Expiry date of older oil futures contract per barrel = $100

S2= spot price at the Expiry date of newer oil futures contract per barrel = $100

Therefore, Roll yield = total change in futures price - total change in spot price = (F2 - F1) - (S2 - S1)

Roll yield = $60-$65 = -$5

It means Alex would suffer a negative roll yield of $5 per barrel of oil.

Frequently Asked Questions (FAQs)

1. Is roll yield guaranteed profit?

No, roll yield is not a guaranteed source of profit. It depends on accurate predictions of future price movements and market conditions. Unexpected changes in market dynamics can lead to different outcomes.

2. How does roll yield affect investment decisions?

It can impact decisions on holding, rolling over, or closing out futures positions. Positive roll yield might encourage investors to maintain their positions, while negative roll yield could prompt them to reconsider their strategy.

3. Is roll yield the same for all commodities and markets?

No, roll yield varies across commodities and markets due to differences in supply and demand characteristics, storage costs, and other factors. Each market has its own unique roll yield dynamics.

4. What factors influence roll yield?

Factors influencing roll yield include supply and demand dynamics, storage costs, interest rates, market expectations, and economic conditions. These factors can lead to changes in the price difference between contracts.