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From Theory to Practice

Cost of Carry: Part 1

| May 13, 2016
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From Theory to Practice

Cost of Carry: Part 1

May 13, 2016

The cost of carry, a concept that is frequently referenced or alluded to, is often times stated in the context of a cure-all to explain all pricing discrepancies in the marketplace. But, what does it actually mean, and why is it necessary? In this segment, we look at the relationship between spot prices and futures prices to better understand how the cost of carry factors into the contango and backwardation we observe in the marketplace.

Spot prices represent the cost to trade the asset in the market today, whereas the futures price points to a price that two parties agree upon today, with the actual transaction of the asset occurring at some later date. The difference between the spot price and the futures price is entirely a function of the cost of carry related to the asset. The cost of carry is a function of several different variables. The risk-free rate and any storage costs associated with holding the asset act as “costs” in the cost of carry, and they push the futures price up relative to the spot price. The convenience yield and any income that owning the asset might confer act as “offsetting forces” in the cost of carry, and they push the futures price down relative to the spot price. Two examples of this relationship are shown: a physical commodity (oil) and a financial asset (S&P).

This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.

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