CFA Level IAlternative InvestmentsHard
A commodity trader holds a long position in a near-month futures contract priced at $78 per barrel that is about to expire. To maintain exposure, she rolls into the next futures contract, priced at $76 per barrel. Which statement best describes the roll yield and the shape of the futures curve?
- AThe curve is in contango, producing a positive roll yield of approximately 2.6%
- BThe curve is in backwardation, producing a negative roll yield of approximately 2.6%
- CThe curve is in contango, producing a negative roll yield of approximately 2.6%
- DThe curve is in backwardation, producing a positive roll yield of approximately 2.6%
Show answer & explanationAnswer & explanation
Correct answer: D. The curve is in backwardation, producing a positive roll yield of approximately 2.6%
Since the near-month price ($78) is higher than the further-dated contract ($76), the futures curve is downward sloping, which is backwardation. Rolling from the expiring contract into a cheaper further-dated contract allows the investor to sell high and buy low, generating a positive roll yield of ($78 − $76)/$76 ≈ 2.63%.
Why the other options are wrong
- A. Misidentifies backwardation as contango despite correctly computing a positive roll yield direction.
- B. Correctly identifies backwardation but reverses the sign of the roll yield.
- C. Incorrectly labels the curve shape; near price above far price is backwardation, not contango.
Roll Yield in Commodity Futures
Roll yield is the return earned (or lost) when an investor rolls a futures position from an expiring contract into a new one; it is positive in backwardation and negative in contango.
- Backwardation: near price > far price → positive roll yield
- Contango: near price < far price → negative roll yield
- Roll yield is a key driver of returns for commodity index investors
Memory trick: Back-warders sell high, buy low — contango costs you dough.