What happens to roll yield as time to maturity increases in a backwardated market?

• A. It decreases
• B. It remains constant
• C. It becomes smaller
• D. It becomes larger

Answer: (D)

In a backwardated market, the futures prices are lower than the spot prices, indicating that the market expects the price of the underlying asset to rise in the future. As time to maturity increases, the roll yield becomes larger in this scenario.

Roll yield arises from the price relationship between futures and spot prices, particularly when an investor holds a position in futures contracts and rolls them over as they approach expiration. In a backwardated market, when the futures contract is sold to purchase a new contract with a later expiration, there is typically a gain realized due to the difference between the higher spot prices and lower futures prices.

As time progresses towards the maturity date, the opportunity to capture these price differences increases, especially if the market conditions remain consistent and backwardation continues. Therefore, as maturity increases, the roll yield becomes more pronounced, leading to larger roll yields received by investors holding short positions in futures contracts during periods of backwardation.