Continuous Futures Construction and the Tradeoffs of Rollover Methods
Summary
This guide explains why futures contracts for the same underlying can have different prices at successive expiries. It defines contango and backwardation and links the price gap to carrying costs such as financing, dividends, or storage. Because a continuous futures history must join contracts that do not trade at identical prices, the rollover method can alter both signals and measured returns.
The document compares four approaches: unadjusted splicing, additive forward or backward adjustment (often called Panama adjustment), proportional adjustment, and a weighted transition across several days. Unadjusted joins preserve observed prices but create jumps; additive shifts can distort trends and returns; proportional scaling supports percentage-return continuity but complicates absolute-price signals; and gradual rolling smooths transitions while potentially increasing transaction costs. It also describes contract-specific roller tools and diagnostics, but supplies no comparative performance results. The appropriate construction depends on the strategy, execution, and contract. Continuous series are analytical constructions, so backtests should account for adjustment effects and the costs of trading during a roll.
Key ideas
- Contango means the later-dated contract costs more than the nearer contract, while backwardation describes the reverse relationship.
- Unadjusted splicing introduces roll gaps that can distort indicators and backtested profit and loss.
- Additive adjustment smooths joins but can create trend drift and make return calculations unreliable.
- Proportional adjustment preserves percentage continuity but can distort absolute price levels used by trading rules.
- Gradual weighted rolling smooths transitions but can require trading over multiple days and raise transaction costs.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.