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Futures, Indices, and Commodities · Calendar Spreads and Basis

The roll yield in commodity ETFs

Understand why long-only commodity ETFs like USO and UNG can underperform spot prices badly — and why the futures curve is the culprit.

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Futures, Indices, and Commodities

Calendar Spreads and Basis

Lesson 37 of 4976%
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Lesson 37 of 49Futures, Indices, and CommoditiesCalendar Spreads and Basis

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Understand why long-only commodity ETFs like USO and UNG can underperform spot prices badly — and why the futures curve is the culprit.

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Why USO is not actually crude oil

Walk into any brokerage app and search for oil. You'll find USO. The ticker stands for United States Oil Fund, and most retail traders assume it tracks the price of crude oil one-for-one. It does not. USO holds front-month WTI crude oil futures contracts. Every month, before those contracts expire and force physical delivery, USO has to sell them and buy the next month out. That mechanical roll is where the trouble starts.

Here's the math. If the front-month contract is at 70 dollars and the next month out is at 72 dollars — a normal contango — USO sells its 70-dollar contracts and buys 72-dollar contracts. To maintain the same number of barrels of exposure, it buys fewer 72-dollar contracts than it sold 70-dollar ones. The fund just lost about 2.8 percent of its exposure to the roll. Do that twelve times a year and you can lose 15 to 25 percent of your exposure annually, even if the spot price of oil hasn't moved at all. That hidden drag is called negative roll yield, and it's the reason USO has historically underperformed crude oil by huge margins over multi-year holding periods.

Wick shows a calculator reading -2.8% after selling $70 contracts and buying $72 ones, showing how a long oil fund loses exposure each time it rolls in contango.Sell at $70, buy at $72-2.8%
Wick saysRolling from $70 to $72 contracts loses about 2.8% of exposure in one month.
Wick thinks that USO holds futures, not barrels of oil, teaching that commodity funds must roll every month and can trail the spot price over long holds.USO holds futures,not barrels of oil.?
Wick saysUSO and UNG hold futures, so the curve shape is part of the trade, not just spot.

The good news: when the curve flips to backwardation, the math reverses. The fund sells the expensive front-month and buys the cheaper next month, ending up with more contracts than it started with. That's positive roll yield. From 2022 to 2023, when oil was sharply backwardated, USO actually outperformed spot crude. But for most of the last decade, oil and gas have lived in contango, and the long-only ETFs have suffered for it. If you want commodity exposure beyond the very short term, this is the most important sentence: the curve shape is part of your trade.

Wick points at a chalkboard saying the roll costs in contango and pays in backwardation, showing the curve shape decides whether a fund's monthly roll helps or hurts.Roll yieldContango: roll costsBackwardation: roll pays
Wick saysRolling costs money in contango and earns money in backwardation.

Recap: USO and UNG hold futures, not physical barrels. Monthly rolls cost money in contango (negative roll yield) and earn money in backwardation. Multi-year holding can destroy huge percentages of return even when spot is flat. The curve is part of every commodity ETF position whether you wanted it or not.

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1. Why does USO underperform spot crude oil over multi-year periods in a contango market?

2. Crude oil suddenly enters sharp backwardation. What happens to USO's roll yield?

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