Cost of Carry
Cost of carry is the total net cost of holding or 'carrying' a position in an asset over a period of time, encompassing financing costs, storage expenses, insurance, and any income generated by the asset (dividends, coupons, convenience yield). It is the foundational concept of futures pricing, determining the relationship between spot prices and futures prices for storable assets.
Key takeaways
- For financial assets: Cost of Carry = Financing Cost − Income. For commodities: Cost of Carry = Financing + Storage + Insurance − Convenience Yield.
- The no-arbitrage futures price incorporates the full cost of carry: F = S × e^(r+u−y)T, where r = financing, u = storage, y = convenience yield.
- Positive carry means income exceeds financing costs (e.g., holding a high-dividend stock financed at low rates); negative carry means the opposite.
- Carry trades — borrowing in low-rate currencies and investing in high-rate currencies — exploit positive carry across currencies, but carry risk includes sudden currency reversals.
- In options, carry affects delta-hedging costs: the total P&L of a delta-hedged option position reflects carry, theta, and gamma.
Explanation
Cost of carry ties together the spot and forward/futures pricing of virtually every asset class. The concept rests on the principle of no-arbitrage: if holding the physical asset and holding a futures contract on the asset provide equivalent economic exposure, their pricing must be consistent with the cost of bridging between the two.
For equity index futures (e.g., S&P 500 E-mini): Carry = Risk-free Rate − Dividend Yield. When the risk-free rate exceeds the dividend yield, the futures trade at a premium to spot (positive carry, contango). When dividends exceed the risk-free rate (unusual, but possible in high-yield equity environments), futures trade at a discount (negative carry, implicit backwardation). The fair-value futures price: F = S × e^(r−q)T where q is the continuous dividend yield.
For fixed income (repo market): A Treasury bond position funded through the overnight repo market has a daily carry = (Coupon Accrual) − (Repo Rate × Price). Positive carry exists when the coupon rate exceeds the repo rate. In an inverted yield curve environment, short-term repo rates may exceed long-term coupon rates, creating negative carry on long Treasury positions.
For currency carry trades: an investor borrows in Japanese yen at 0.1% and invests in Australian dollars at 4.5% earns approximately 4.4% annual carry (abstracting from currency moves). The carry is positive but fragile — sudden 'carry unwinds' (risk-off episodes where high-yielding currencies sell off sharply) can eliminate multiple years of accumulated carry income in days. Burnside et al. (2011) documented that currency carry trade returns are compensation for rare but large negative skewness — the strategy 'picks up nickels in front of steamrollers.'
The carry factor is one of the best-documented cross-asset return premia in empirical finance. Koijen et al. (2018) showed that the carry trade is profitable across equities (high-dividend stocks outperform low-dividend), bonds (steeper curves generate more carry), commodities (backwardated commodities outperform contangoed ones), and currencies (high-yield currencies outperform low-yield). Carry can be understood as compensation for liquidity risk, crash risk, and the fundamental uncertainty about whether carry reflects risk premia or exploitable mispricing.
Formula
F = S × e^(r + u − y)T | Equity Futures Fair Value: F = S × e^(r − q)T
Example
A commodity trading fund holds a long position of 1,000 gold futures contracts (100 troy oz each) expiring in 6 months. Gold spot price: $2,400/oz. The fund's financing cost (6-month Treasury rate): 5.2% annualized. Storage and insurance: $0.25/oz/month ($1.50 for 6 months). No convenience yield (gold has negligible industrial demand relative to supply). Total 6-month cost of carry = $2,400 × (0.052/2) + $1.50 = $62.40 + $1.50 = $63.90/oz. The 6-month gold futures should trade at approximately $2,400 + $63.90 = $2,463.90/oz. If the market quotes the 6-month futures at $2,475, the futures are $11.10 'rich' to fair value — a potential cash-and-carry arbitrage opportunity (buy spot, sell 6-month futures, earn riskless $11.10/oz above carry cost).
Related terms
Arbitrage Back Months Backwardation Bond Carry Trade Contango Coupon Rate Deferred Futures Dividend Dividend Yield Dominant Future Equity