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I have a quick question about the ETF Roll Yield. As we all know commodity ETF’s have struggled with contango (spot price is below futures prices on the term structure). Look at an ETF like USO which because of the contango in WTI has had negative roll yield even as WTI prices have rebounded since 2008.

Here is my question. Why does the roll yield even occur? If an ETF like the USO is long the spot why does it have to roll into a higher price contract? Wouldn’t the futures price and the spot eventually converge by the time the roll occurs? The future price is higher than the spot in a contango wouldn’t the spot have to move higher to reach the futures price? I mean the futures can decline to the spot but I don’t see how this affect you if your long the spot.

If the USO isn’t long the spot but further out oil contracts, what guarantees that futures price will converge to the spot in a contango curve? So contango doesn’t have to necessarily be a bad thing for a long commodity investor/etf.

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The futures price goes to the spot price as time to maturity declines, not vice-versa. The difference is referred to as basis. That's not really what roll yield is about though. The roll yield aspect is that as the contracts the ETF holds are expiring, they are close to the spot price. However, the next futures contract's price is higher than the price of the futures contract you're in due to the effect of contango. So if you were to sell out of the closest futures contract to buy the next one, it would cost more to achieve the same exposure it had before.

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  • $\begingroup$ Hi John,Thank you for your reponse. Are you the the futures prices always converges to spot price? Cannot the spot converge to the futures as well? Or both converging to one another? $\endgroup$
    – jessica
    Aug 29, 2013 at 18:01
  • $\begingroup$ Is the roll yield associated with the fact, even though there is a convergence. The convergence isn't perfect, the two contracts will differ slightly in price, and hence there will be associated costs of rolling. $\endgroup$
    – jessica
    Aug 29, 2013 at 18:02
  • $\begingroup$ For your first question, I'm simply relying on the arbitrage arguments that lead to futures pricing. You seem to be very interested in the empirical dynamics, which I am silent on. For your second, imagine you had a CLU3 contract (WTI on CME) on 8/20 (priced at close at 104.96). It stopped trading that day, so you would need to switch to a CLV3 contract (priced at 105.11). You would have to put up more money to continue to have a 1 contract position. That's how I think about roll yield. $\endgroup$
    – John
    Aug 29, 2013 at 22:23
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If an ETF like the USO is long the spot why does it have to roll into a higher price contract?

This is wrong. An ETF is not always long spot (at least not USO). ETF try to create spot returns by using first month future contract. Imagine the amount of storage space required by USO issuer to store all that spot oil.

If the USO isn’t long the spot but further out oil contracts, what guarantees that futures price will converge to the spot in a contango curve?

There is no guarantee. But the forward curves of commodities tend to change very slowly. So during contango period, typically there are more buyers for forward month contract compared to spot and situation tends to continue over period of multiple futures contract expiries. During such a period, an ETF provider (or even just long only investor who gains exposure using futures contracts) will have to keep on buying the front month contract at higher price than typically where he/she would be able to sell at end of that contract expiry.

Contango is almost always bad for long only invesor.

Another classic example of ETF suffering due to contango is VXX.

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