At the bottom of page 28, the reading defines roll yield as the change in the futures price minus the change in the spot price of the underlying commodity. This makes sense.
It also defines backwardation as a downward sloping term structure of futures prices (i.e. each successive futures price is lower). This also makes sense.
The part I am having trouble grasping is that it states that backwardation predicts a positive roll yield. Is this a typo? It doesn’t make any sense to me how downward sloping futures prices could predict a positive roll yield… If somebody could either confirm that this is a mistake or help me understand the concept it would be greatly appreciated.
There is a lot on the forum on this question. Here is a previous thread that might help:
Thanks. Makes more sense now. Not sure I 100% get it conceptually but should be easy enough to remember for exam time.
There’s also an example at the top of Schweser pg 110 book 4 that helps. Does’nt talk about changes in fwd/spot but does help in the conceptual part of things. I suspect the “change” portion has to do with rolling through two contracts, while this example was just a very basic one time roll yield.
backwardation occurs when the futures price is lower than the spot is right now. Because the futures converges to the spot at expiration , the futures must rise gradually to meet the spot.
When you roll a futures contract you are really seling the appreciated fuitures instrument and buying a new futures contract . Because the spot and the futures instrument you are selling should be close in price , you are literally selling high , and then buying a different contract with a lower price.
Next month the contract you bought when it was low , has appreciated to equal the spot ( backwardation and then convergence to spot) . So again you sell the high contract and buy a new contract at a lowe price. This buy low-sell high strategy gains when there is backwardation . The yield in the strategy is referred to as roll-yield because you are rolling to next contract each time