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FRM Part I · FRM Exam Part I · Futures Markets

A futures contract on a commodity is currently priced at 82 for the nearby contract and 79 for the next maturity contract. A hedger holding a short hedge wants to roll the position forward by closing the nearby contract and opening the next one. Which statement best describes the market structure and the roll effect on the short hedger?

The curve is in backwardation because the nearby price of 82 exceeds the deferred price of 79. A short hedger buys back the nearby at 82 and sells the deferred at 79, so the roll costs 3 per unit and is a negative roll yield for the short.

  1. AThe market is in backwardation, and rolling a short hedge by selling the later contract at a lower price produces a negative roll yield for the shortCorrect
  2. BThe market is in contango, and the short hedger earns a positive roll yield
  3. CThe market is in backwardation, and the short hedger earns a positive roll yield because the later contract is sold at a lower price
  4. DThe market is in contango, and the short hedger faces a negative roll yield

Explanation

Nearby 82 above deferred 79 means backwardation (downward-sloping curve). The short buys back the nearby at 82 and sells the deferred at 79, locking in a lower selling price, a 3 loss relative to the nearby; this is a negative roll for a short. For longs in backwardation the roll is positive. Options referring to contango misidentify the curve shape.

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