Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

What is the definition of roll return in the context of futures contracts?

1. It is the total profit from closing a futures position.

2. It is the portion of the return attributable to the change in the contract's basis over time.

3. It refers to the immediate profit from selling the contract.

4. It is the yield generated from holding an asset for one year.

The correct answer is: It is the portion of the return attributable to the change in the contract's basis over time.

Roll return refers to the gains or losses associated with rolling over a futures contract to a later expiration. In the context of futures contracts, the basis is the difference between the spot price of the underlying asset and the futures price. As time progresses and the expiration of a futures contract approaches, the futures price will often converge with the spot price of the asset. The roll return captures the changes in this basis, meaning it reflects the income or loss earned from transitioning from one futures contract to another with a later expiration date. When futures contracts are in contango (where futures prices are higher than spot prices), rolling over might yield a negative roll return since an investor must buy the more expensive contract. Conversely, in a backwardation scenario (where futures prices are lower than spot prices), the roll return will be positive as the investor benefits from the convergence of prices. This understanding highlights the essential role of the futures market's pricing mechanics and time decay, making roll return a significant component of total return for those utilizing futures contracts as part of an investment strategy.