What is this? Relates to use of futures. Schweser p. 164 in GIPS material
the risk - when a futures contract expires - due to the difference in price between a new futures contract and the old futures contract?? don’t have books in front of me…just my first thoughts…
Someone answered rollover risk perfectly before - in fact I’ve saved his review. This should answer your questions thoroughly. Roll Return there are 2 different curves which seem opposite, which make it confusing: 1) term structure curve - if the benefits of owning the physical (eg from dividends, coupons, convenience yield, net of storage, etc) exceed the cost of funding it (the RFR), then fwd price will be lower than spot - so term structure curve is downward sloping to the right (just like an inverse interest rate yield curve, where bond yields are lower than cash, etc) so, because Fwd price is below Spot (Backwardation), it must converge (rise) to the Spot price toward expiry - so you get positive Roll return (rising Fwd price) each time you roll contracts toward expiry. So if you look at it as a Term Structure curve, you ALWAYS MOVE LEFT over time toward expiry, which is LEFT toward the left y-axis (the opposite = Contango, which is like a “normal” interest rate term structure curve - ie upward sloping to the right. But as you roll contracts toward expiry, you move LEFT along the curve and the Fwd price FALLs toward Expiry as it converges toward the Spot price, so you get negative roll return) 2) if you plot the Fwd price over time (ie moving left to right which is how most people think) - Backwardation produces an upward sloping curve moving from left to right, so you also get positive Fwd price as you move RIGHT. But because you are moving RIGHT over time, you get the opposite curve to a “term structure” curve. To keep everything consistent - it makes more sense if I think about ALL prices (interest rates, commodities prices, share prices, etc) as a Term Structure curve - ie ALWAYS MOVE LEFT over time - just like an interest rate term structure curve. If you follow the same approach for all assets it is consistent. Always move LEFT over time toward Expiry. So: - Backwardation = upward sloping moving LEFT over time --> positive roll return as price rises to converge on Spot (like inverse yield curve). (The “upward” sloping means you draw a line upward from right to left as you move LEFT toward expiry - ie spot price) - Contango = downward sloping moving LEFT over time --> negative roll return as price falls to converge on Spot. (like normal yield curve) (The “downward” sloping means you draw a line downward from right to left as you move LEFT toward expiry - ie spot price) It really doesn’t matter which type of curve you remember, as long as it is consistent with all assets. So I stick to the yield curve convention term structure. memory tip: if [B]enefits exceed costs --> [B]ackwardation --> Fwd price is [B]elow Spot (think B-B-B) if [C]osts exceed benefits --> [C]ontango (think C-C) hope this helps…
Yeah, this was null&nuller. Thanks PB.
wow, very helpful. Thanks