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Answer: The spot price was dropping even more than the futures prices
A stack-and-roll hedge repeatedly closes expiring futures positions and opens new longer-dated contracts. The roll yield depends on the shape and movement of the futures curve. A **negative roll yield** can occur even when futures prices are falling if the **spot price is falling even faster**. In that case, the curve can shift so that the replacement contract is relatively more expensive than the contract being sold, turning the roll into a loss. Why the other choices are less accurate: - **A** is not necessary; convergence can still occur. - **C** would generally support stronger backwardation, not losses from the roll. - **D** is incorrect because stack-and-roll hedges are sensitive to curve shape changes. Therefore, the correct answer is **B**.
Author: Manit Arora
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Question 143.4. In the Metallgesellschaft case study, the company hedged by employing a stack-and-roll hedge: this entailed taking long positions in short-term oil futures contracts. During oil backwardation, owing to the convergence of futures and spot prices, this produced a profitable roll yield. But the roll return started to produce losses even as futures prices were dropping! How could the decline in futures prices allow for negative roll yield (losses on the roll)?
A
The convergence of spot and futures failed to occur (a breakdown in the convergence assumption)
B
The spot price was dropping even more than the futures prices
C
The spot price was increasing even more than the futures prices
D
As opposed to a strip hedge (where this would not happen), the stack-and-roll hedge is insensitive to backwardation/contango shifts
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