Impact of Contango and Backwardation on Futures Returns

Very Hard Commodities Investment Commodity Futures

In the sophisticated landscape of commodities investment, a hedge fund manager has allocated a significant portion of the fund's capital to commodity futures, viewing them as an attractive option for both inflation protection and diversification purposes. The manager is particularly focused on the impact of contango and backwardation on the expected returns from these futures contracts.

To hedge against potential price increases in crude oil, the manager has decided to go long on future contracts expiring in six months. However, uncertainties regarding geopolitical tensions and fluctuations in demand have raised concerns about potential losses.

Given this context, which of the following statements best describes the effects of contango and backwardation on the returns from holding these futures contracts?

In contango, the futures price is higher than the spot price, which implies that holding long positions will yield a positive roll yield.

In backwardation, the spot price is higher than the futures price, leading to a negative roll yield for long futures positions.

In contango, the holder of long futures contracts will experience a negative roll yield as contracts are rolled from higher-priced futures to lower-priced spot prices.

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