Contrast roll return when markets are in contango with roll return when they are in backwardation
The idea
Roll return is what a long investor gains or loses in replacing an expiring contract with a later one. In backwardation the new contract is cheaper than the one sold, so the proceeds buy more contracts and roll return is positive; if the curve keeps its shape, the cheaper deferred contract also rises towards spot as it approaches expiry. In contango the new contract costs more, fewer contracts are bought and roll return is negative. With the formula (expiring price − new price) ÷ expiring price, the sign follows automatically. The trap is dismissing roll return as bookkeeping: it reflects the term structure and can dominate long-run returns, especially in energy markets where contango can be steep for long periods.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Introduction to Commodities and Commodity Derivatives
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- Analyse how spot and futures prices relate when markets are in contango and when they are in backwardation
- Contrast theories explaining commodity futures returns
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- Explain how commodity swaps can be used to gain or adjust exposure to commodities
- Explain how the way a commodity index is built influences its returns