A long position in backwardation will produce a greater roll return than a position in contango if the price increases.
Can someone explain why that is true? I get that a long position in backwardation produces a greater roll, but I dont understand the comparison to a long in contango IF the price rises.
For reference this is in the CFAI topic test.
In backwardation the futures curve is downward sloping, possibly due to a convenience yield. You can gain just through buy+hold. Backwardation generate positive roll yield. Contango is negative roll yield.
Backwardation market long dated futures < short dated futures and hence the cost of long dated future/s is less. Rolling contracts will thus produce a positive roll yield as the cost is less
http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91343076
my stupid heuristic is “FAS contango Negative Up”
which (to me) means Fut./Fwd. above Spot is contango, earns a negative roll and is upward sloping.
*one thing to remember in a currency hedge is that if you SELL forward the currency, you get a (+) roll yield from contango!
I had a hard time getting this as well.
There is an implicit assumption that when the futures contract expires the spot price at that date will be the same as the spot price is currently.
Contango exists when the futures price is greater than the spot price. You commit to buying the asset at the futures price (say $85) when the spot price is ($80). When the futures contract expires it is assumed that the spot price will be $80 but you are commited to buying the asset for $85 leading to a loss of $5.
Roll yield is always based on the assumptioin that the spot price at the time of expiration is the same as the spot price today so by buying the futures contract you are locking in a retun of the difference between the two prices.
Thanks all, and especially MGurn. Makes sense that if you are long, and the curve is in backwardation, your return will be greater relative to a curve in contango given an uptick in spot prices. Simply have more to gain when you are locked in at say, $5 (instead of $8 if in contango) and the commodity goes to $10; your futures value (but not price) will increase, thus earning you a higher return.
Mark it