Commodity futures curves in practice: roll yield and what ETC investors really earn

What you will learn

• How to split a futures-based return into spot return, roll return and collateral return
• How to calculate and annualise roll yield from a futures curve
• Why an ETC investor's result can differ strongly from the spot price chart
• How roll schedules and changes in curve shape affect what you actually earn

Explanation

Contango, backwardation, convergence and the basic roll are covered in the Derivatives course. This lesson applies them to the investor who holds a commodity product for months or years.

Three sources of return

Most exchange-traded commodities (ETCs) on oil, gas, metals or crops hold futures, not barrels or bushels. A fully collateralised long position means the full contract value sits in cash or short-term government bills, and only part of it is needed as margin. Its return is approximately:

Total return ≈ spot return + roll return + collateral return

• Spot return: the change in the spot or front-month price, the one you see in the news.
• Roll return (roll yield): the gain or loss from holding a later contract as it converges towards spot, realised each time the position is rolled.
• Collateral return: interest earned on the cash.

Index providers publish an excess return version (spot plus roll) and a total return version (excess return plus collateral interest). Check in the product factsheet which one an ETC tracks. Product fees, covered in the next lesson, come on top.

Measuring roll yield from the curve

Annualised roll yield ≈ (F_near − F_far) ÷ F_far × (12 ÷ months between the contracts)

The result is negative in contango and positive in backwardation. It assumes a static curve: the curve keeps its shape while time passes. For a more exact figure, compound the return per roll instead of multiplying.

The curve moves

Curve shape is linked to inventories (lessons 2 and 4): full storage tends to create steep contango, low stocks tend to create backwardation. The shape can change quickly, so a roll yield measured today is not a forecast of the next year. Past periods with positive or negative roll do not tell you which one comes next.

Roll schedules

• Front-month products roll every month on fixed, publicly known days.
• Deferred or optimised products hold later contracts or choose the contract with the least contango. This often reduces roll cost in contango.
• Trade-off: later contracts usually move less than the front month during supply shocks, so you capture less of a sudden spot move.

Worked example

Hypothetical example: one year with a static curve. Assumptions: the oil spot and front month stay at $70.00 all year. Each month the next contract trades 2% higher at $71.40. The investor holds the next contract, which converges to $70.00 before each monthly roll. Collateral interest 3% per year.

1. Return per roll: $70.00 ÷ $71.40 − 1 = −1.96%.
2. Twelve rolls, compounded: (1 − 0.0196)^12 − 1 = −21.2%.
3. Simple annualised formula: ($70.00 − $71.40) ÷ $71.40 × 12 = −23.5% (overstates the compounded loss).
4. With collateral: 0.7885 × 1.03 − 1 = −18.8%.

The spot chart shows 0% for the year; the investor lost about 18.8% before fees.

Mirror case, backwardation: next contract $68.60. Return per roll $70.00 ÷ $68.60 − 1 = +2.04%; compounded +27.4% per year; with collateral about +31.3%, again with spot unchanged.

When spot moves: in the contango case the investor buys at $71.40 and spot rises to $75.00 at the next roll. Spot rose 7.14%; the position gained $75.00 ÷ $71.40 − 1 = 5.04%.

Excluded: product fees, bid-ask spreads at each roll, tracking differences, euro–dollar currency changes and taxes. A euro investor in an unhedged dollar product also carries currency risk.

Common mistake

Practice activity

Hypothetical data, static curve, curve keeps the same percentage shape.

1. A product rolls quarterly. Front month €50.00, next quarterly contract €51.50, spot flat for a year. Calculate the return per roll and the compounded annual roll return.
2. Add collateral interest of 2% per year. What is the total annual return?
3. Calculate the simple annualised roll yield with the formula.
4. Now assume spot rises 10% over the year. What is the approximate total annual return?

Key takeaways

• Total return ≈ spot return + roll return + collateral return.
• Contango produces negative roll return, backwardation positive, if the curve is static.
• A spot chart can hide large differences between the commodity price and an investor's result.
• Roll schedule and index version (excess or total return) change what you earn.

Next step

In the next lesson you look inside commodity ETCs and broad commodity indices: how they are structured and what they cost.