I cant get this concept…In reading 37( Alternative Investments), there is a concept for total return = Spot return + Collateral return + Roll Return. I get the first 2, but cant understand Roll return. It says roll return will be positive if there is backwardation. Please help…
If futures are in backwardation, the further out in time the contract the lower the price. As you approach maturity the futures prices must equal the spot prices (theoretically your shortest futures contact = to now) or an arbitrage opportunity exists. Therefore, you know that the futures price has to rise to converge to the spot price. This increase in prices in the futures is the roll return. That is my understanding.
yeah that is spot on… another way to look at it is that futures expire. thus to keep your position on you must roll it over. example spot crude is 40 march futures is 38 april futures is 36 may futures is 34 thus if you buy march and we are coming up to the end of the month, you will need to roll your position in order to keep it on. so you will sell march and buy april. you will make 2 on the trrade. sold march for 38 and paid 36 for april… this is posttive roll yield… note markets in crude are not in backwardation at the moment. so this would produce negative roll yield…
Thanks nikko0355, I get it now… Demonstrating with an example was good…