What you will learn
- Read a futures curve as contango or backwardation.
- Estimate the roll effect on a position held through successive contracts.
The curve links spot and futures
A futures contract fixes a price today for delivery of a standard quantity at a future expiration date. The futures curve lists those prices for successive expiries and shows how the market prices time.
When later contracts cost more than earlier ones, the curve is in contango, often reflecting storage and financing costs until delivery. When later contracts cost less, it is in backwardation, which often accompanies tight supply and valuable immediate delivery.
Why futures converge to spot
As a contract nears expiration, its price is pulled toward spot, because delivery or cash settlement at expiry is tied to the spot market. A position held at a premium to spot loses that premium over time if spot does not move.
This convergence is why futures returns differ from spot returns. The difference is not a fee but the price of time embedded in the curve.
Rolling positions
To keep exposure going, a holder closes the expiring contract and opens the next. In contango the new contract costs more, producing a negative roll yield if the curve and spot price stay unchanged.
In backwardation the new contract costs less, producing a positive roll yield. Roll yield is one part of return, alongside the spot change and collateral interest, and curve shapes can change, so it is not a guaranteed pattern.
Worked example: Rolling in contango
Assume spot stays at 80.00 and each one-month contract trades 1% above spot, at 80.80. A long position opened at 80.80 converges to 80.00 at expiry, losing 0.80 per unit. Rolling into the next contract at 80.80 repeats this monthly, so over 12 months the roll costs about 12 × 0.80 = 9.60 per unit, near 11.9% of 80.80, although spot never moved.
Check your understanding
In backwardation, spot is 100.00 and the one-month contract is 99.00. With spot and the curve shape unchanged, what is the monthly roll gain per unit, and roughly what percentage of 99.00 over six months?
Show answer and explanation
A contract opened at 99.00 converges up to 100.00, a gain of 1.00 per unit a month, about 1.01% of 99.00. Over six months that is about 6.00 per unit, roughly 6.06%, before compounding, collateral interest and costs. If spot or the curve shifts, the result changes.