Commodity trading can be a complex world to navigate, with many concepts that are essential to understand. One term you are sure to encounter is “convenience yield” – keep reading to find out what it means!
What Is A Convenience Yield?
A convenience yield is a benefit or premium that comes with owning a physical commodity, as opposed to holding its derivative securities or contracts.
What You Need To Know About The Convenience Yield
Let’s dive deeper into the convenience yield definition by looking at an example. Consider an investor who is interested in owning gold. They can purchase gold futures contracts or exchange-traded funds (ETFs) that track the price of gold, or they can opt for physical gold bullion.
By owning the physical gold, the investor gains the convenience yield of being able to store the commodity themselves, inspect it for authenticity, and potentially use it for other purposes such as jewelry or collectibles.
Additionally, in times of market instability or economic uncertainty, physical gold can act as a hedge against inflation and offer a sense of security that cannot be achieved through owning futures contracts or ETFs alone.
Thus, the convenience yield concept plays an important role as a means of reflecting why owning physical commodities can offer more benefits than trading derivatives. Moreover, the convenience yield can be a useful tool for commodity traders looking to manage risk.
Note that the convenience yield is not directly observable in the market, but can be estimated using a variety of methods. One common approach is to use the difference between the futures price and the spot price of a commodity. The resulting value is called the “basis” and represents the cost of carry, which includes storage costs, interest rates, and other expenses associated with holding a physical commodity.
By subtracting the basis from the futures price, you can estimate the market’s expectation of the spot price at the time the futures contract expires, which can help to infer the convenience yield.
