The term "cost of carry" refers to the expenses incurred in holding or carrying a financial or physical asset over a specific period. It represents the cost associated with owning and storing an asset, or the cost of financing and maintaining inventory or positions held in the markets. This concept is widely used in finance, commodities, and derivatives markets.
In financial markets, the cost of carry includes various factors such as interest expenses, storage costs, insurance fees, and dividend payments. For example, in the context of stock trading, the cost of carry takes into account the interest paid on margin loans or the costs of borrowing funds to buy securities. In commodities markets, it involves the expenses related to storing and insuring physical commodities like oil or agricultural products.
The cost of carry becomes particularly relevant in derivative trading, especially in futures and forwards contracts. In these cases, the cost of carry is represented by the difference between the spot price and the futures price, taking into consideration factors such as interest rates, storage costs, and expected dividends or income. This difference represents the carrying costs over the life of the contract.
Understanding the cost of carry is crucial for investors, traders, and risk managers as it allows them to evaluate the profitability and risks associated with holding or trading certain assets. By assessing the cost of carry, market participants can make informed decisions regarding their investment or trading strategies to maximize their returns and optimize their risk exposure.
