Futures Return

Futures Returns have multiple subcategories of performance metrics that combine to create the total futures return. Each mechanism functions slightly differently. They also come in a specific order. The spot return comes first, collateral return second, and roll return third. These combine to form your total futures return.

Spot Return

The spot return is the profit from the difference between the future contract’s delivery price and the underlying asset’s spot price. The spot price is the current market price of an underlying asset at a particular place. At the time of delivery, if the spot price is higher than the delivery price goods are sold for less than market value. You can immediately sell the asset and earn a profit. If the spot price is lower than the delivery price, you pay more for the underlying asset than you can buy it on the market. You suffer a loss if you sell the good on the open market. Note that future’s contracts are not options. You are contractually obligated to buy on the long side, or alternatively sell on the short side. You can receive either the asset or its value in stated currency at the delivery date, depending on the future’s requirements.

Collateral Return

The collateral return is interest earned between the future’s purchase and the delivery date. It is also known as the interest return. If you buy a future contract on an underlying asset, you only spend a fraction of the money that it costs to buy commodities outright. You may spend only $5k USD on futures that will eventually deliver $100k. This means there’s a $95k difference. You will eventually need that $95k before the delivery date. You place the money in principal safe investments that mature, or can be sold for full value plus return, before the delivery date. The return you earn on the $95k invested is the Collateral or Interest return.

Roll Return

The roll return is earned between the delivery date of one future and the purchase of any replacement future. Future contracts expire either monthly or quarterly. If continuously trading futures contracts, after the delivery date you must replace your expiring future with another. Reinvestment is where the roll return is generated. If the prices for similar futures are higher, your roll return is a loss. You can buy less futures, thus capture less profit, with the same amount of money. If the prices for similar futures are lower, your roll return is profit. You can buy more futures, thus capture more profit, with the same amount of money.

This occurs in individual futures, but becomes a trend in the marketplace. If prices in the marketplace are trending upward, the market is in Contango and roll return losses are common. If the prices are in the marketplace are trending downward, the market is backwardated, and roll return profits are common.

Total Futures Return

The total futures return is the combination of all 3 factors. Interest or collateral comes first, spot return comes second, and roll return comes third. If you’re aware, and opportunistic, of all three separate returns you can consistently earn large total returns.