Explanation:
If the spot price and the futures curve remain unchanged, the producer keeps shorting near-dated futures that are below the eventual spot price at expiration. Each contract is effectively sold at a lower futures price and later closed at the unchanged spot price, creating a negative roll yield.
Because the futures prices are below spot and do not shift, the hedge rolling process produces losses due to the roll yield.
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Q-156.2 Rolling the hedge forward
Assume the same scenario as the previous P1.T3.: The spot price of oil is $106, the one-month futures price is $102, and the 12-month futures price is $98. If the spot price and the oil futures curve do not shift at all during the entire one-year period, while the oil producer employs the stack-and-roll hedge (e.g., at the end of the one year, the spot price is unchanged at $106), what will be the net performance of rolling the hedge forward without regard to the underlying future sale of spot oil (ignoring transaction costs)?
A
Losses due to the roll yield
B
Approximately breakeven (no gain or loss)
C
Gains due to the roll yield
D
Not enough information