Roll-Down

The hidden return in bonds that most investors ignore.

The Free Lunch That Isn't

Even if interest rates don't move at all, a 10-year Treasury can generate 0.5% extra return per year. It's not a coupon payment. It's not a rate rally. It's something more subtle: roll-down.

Here's the insight: today's 10-year bond becomes a 9-year bond tomorrow. On a normal upward-sloping yield curve, 9-year bonds trade at lower yields than 10-years. Lower yields mean higher prices. You just made money doing nothing.

Professional traders obsess over roll-down. It's a key input in every bond portfolio decision. Some sectors of the curve have excellent roll; others have almost none. Knowing where to position for maximum roll is a core skill in rates trading.

The catch: Roll-down only works when the curve is upward-sloping. When curves invert, roll-down becomes roll-UP loss. You roll into higher yields and lower prices. The "free lunch" turns into a daily bleed.

Historical Roll-Down Examples

The value of roll-down depends entirely on curve shape. Study these historical moments:

Steep Curve Paradise

Roll: +78 bps/yr Carry: +85 bps/yr

The Setup

With the Fed pinned at zero and vaccines rolling out, the curve was historically steep. The 10Y-9Y yield pickup was over 15bps. Professional investors loaded up on belly duration specifically for roll-down.

What Happened Next

Roll-focused strategies delivered 50-80bps of extra annual return before the Fed hiking cycle began in 2022. The steep curve persisted for nearly two years.

Where Roll-Down Comes From

Curve Slope Matters

Roll-down is proportional to the yield difference between your current maturity and your rolled maturity. Steep curves = big roll. Flat curves = no roll. Inverted curves = negative roll.

Example: If 10Y yields 4.5% and 9Y yields 4.3%, rolling down one year captures a 20bp yield pickup. But if they both yield 4.5%, there's nothing to capture.

Duration Amplifies

The price impact of rolling to a lower yield depends on duration. Longer-duration bonds benefit more from the same yield pickup. This is why the "sweet spot" for roll is often in the belly (5Y-10Y).

Example: A 10bp yield pickup on a 2-year bond (duration ~2) gives ~0.2% return. The same 10bp on a 10-year (duration ~8) gives ~0.8%.

Time Horizon Scales

Roll-down is typically quoted annually but accrues continuously. A 1-year holding period captures the full roll; a 6-month hold captures roughly half. Timing matters for maximizing roll return.

Example: If annual roll-down is 50bps, expect ~25bps over 6 months, ~12bps over 3 months. But this assumes a stable curve.

Finding the Best Roll Sectors

Not all parts of the curve roll equally. Professional portfolio managers constantly scan for the best roll opportunities. The ideal sector combines steep local slope with reasonable duration.

Market Scenario:

Roll-down by sector on a steep curve:

Roll Yield Pickup Duration Roll Return

3Y -> 2Y 50.0 bps 2.8yrs +1.40%

5Y -> 4Y 35.0 bps 4.5yrs +1.56%

7Y -> 6Y 25.0 bps 6.0yrs +1.49%

10Y -> 9Y 16.7 bps 8.0yrs +1.33%

20Y -> 19Y 5.0 bps 12.6yrs +0.63%

30Y -> 29Y 1.0 bps 15.2yrs +0.15%

On a steep curve, the 7Y-10Y sector often offers the best roll. High duration plus steep slope equals maximum roll capture.

Total Return: Carry + Roll + Price Change

Professional traders never think about carry or roll-down in isolation. They always calculate total return: what you earn from carry, plus what you earn from roll, plus (or minus) any price change from rate moves.

Carry

Coupon income minus financing cost. Positive on steep curves; negative on inverted curves.

Roll-Down

Price gain from rolling to lower yields. Positive on steep curves; negative on inverted curves.

Price Change

Gain or loss from parallel rate moves. This is where most of the P&L volatility lives.

The key insight: Carry + roll creates a "cushion" against adverse rate moves. If your carry + roll is 80bps annually, rates can rise ~10bps (on 8-year duration) before you lose money. This is your breakeven yield change.

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Trading Strategies Using Roll-Down

Ride the Roll

Buy bonds in steep sectors, hold for roll, sell before rolldown diminishes.

Best environment: Steep curve with stable rates. You want the curve shape to persist while you capture roll.

Example: In 2021, buying 10Y notes and holding for 1 year captured 50-80bps of roll return on top of carry. With rates stable, this was nearly free money.

Roll-Adjusted Curve Trades

Account for differential roll when constructing steepeners/flatteners.

Key insight: Different sectors roll at different rates. A steepener might have asymmetric roll that affects your carry over time.

Example: A 2s10s steepener where 10Y has much better roll than 2Y will earn positive roll carry even if the curve doesn't move.

Avoid the Roll Trap

On inverted curves, don't be long duration expecting roll to save you.

Warning sign: When the curve is inverted, every day you hold costs you roll. Combined with negative carry, you're bleeding constantly.

Example: In 2023, being long 10Y cost ~150bps in negative carry plus ~50bps in negative roll annually. You needed rates to fall 2%+ just to break even.

Trade Examples (Simple)

Here are three concrete examples showing how roll-down works in practice:

Example 1: Riding the Roll (Steep Curve)

The Trade: You buy $10M of 10-year Treasuries at 4.5% yield. The 9-year yields 4.3%.

How It's Funded: You put up $500K margin and repo-finance the $10M position. Your total return = carry (coupon - repo) + roll-down. With 20x leverage on a 3% total return, your $500K equity makes $300K = 60% return. But leverage cuts both ways.

What Happens: You hold for 1 year. Your 10Y becomes a 9Y. Curve doesn't change.

Your P&L: Your bond "rolls down" to the 9Y yield. 20bp yield drop x 8 duration = 1.6% gain. $10M x 1.6% = +$160,000

Plain English: You made $160K without rates moving at all. Your bond just got shorter and shorter-term bonds yield less on a steep curve. That's roll-down.

Example 2: Roll-Down Disappointment (Flat Curve)

The Trade: You buy $10M of 10-year Treasuries at 4.5% yield. The 9-year also yields 4.5%.

How It's Funded: Same mechanics - repo finance with margin. But with no roll-down, you only get carry. If carry is also thin (flat curve often means rates are similar across tenors), the leveraged return is minimal.

What Happens: You hold for 1 year. Your 10Y becomes a 9Y. Curve is flat.

Your P&L: No yield pickup from rolling = no roll-down return. $0 from roll.

Plain English: When the curve is flat, there's nowhere to roll TO. You still get carry (coupon minus financing) but zero roll-down bonus.

Example 3: The Full Picture (Carry + Roll)

The Trade: Steep curve 2021. You buy $10M 10Y at 1.5%, finance at 0.1%, 9Y yields 1.3%.

How It's Funded: You put up $500K margin, finance at 0.1% repo. Carry (1.4%) + Roll (1.6%) = 3% total. On $10M that's $300K. On your $500K equity, that's 60% annual return. This is why hedge funds loved steep curves in 2021.

What Happens: You hold 1 year, curve unchanged.

Your P&L: Carry = 1.4% (+$140K) + Roll-down = 1.6% (+$160K) = Total 3.0% (+$300K)

Plain English: On a steep curve you get paid twice: once for the carry (coupon vs financing), once for the roll (moving to lower-yield part of curve). $300K for doing nothing. But only works when curve is steep!

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