Cost of Carry

The cost of carry is the sum of all costs (and sometimes benefits) of owning and holding an underlying asset from today until a future settlement date. It includes storage fees, insurance, financing costs (interest), and may subtract convenience yield or dividend income. The cost of carry directly determines the forward-contract price and the basis between spot and futures contract prices. Higher cost of carry raises futures prices above spot prices, creating contango.

Components of cost of carry

Storage: Physical cost of holding the asset. Oil in a tank, gold in a vault, wheat in a silo. Typically a fixed percentage of asset value per year or a fixed absolute fee.

Insurance: Risk of loss or damage during storage. As a percentage of value.

Financing: Interest cost of borrowing money to purchase the asset. If you buy oil at $70 and borrow at 2% annual rate for 6 months, the financing cost is roughly $0.70.

Convenience yield: Benefit of holding the physical asset (not applicable to all assets). A refinery benefits from immediate oil supply; this reduces the effective cost of carry.

Dividend yield: For stocks paying dividends, the dividend reduces the cost of carry. Owning stock instead of buying a future lets you collect the dividend.

Futures pricing and carry

The relationship is:

Futures Price = Spot Price × e^(r×T + storage − convenience_yield − dividend)

For a stock with 2% annual financing cost, 0% storage, 2% dividend yield, and T = 0.5 years:

Futures = Spot × e^((0.02 − 0.02) × 0.5) = Spot

The futures price equals spot; no contango or backwardation because carry components cancel.

For crude oil with 2% financing and 1% annual storage:

Futures = Spot × e^((0.02 + 0.01) × 0.5) = Spot × e^(0.015) ≈ Spot × 1.0151

Futures are 1.51% higher than spot—contango.

Carry trade: arbitrage opportunity

When the basis (futures − spot) exceeds the cost of carry, an arbitrage is available:

1. Buy spot (e.g., crude at $70)
2. Store and finance for 6 months
3. Sell 6-month futures at $71.50
4. Total cost: $70 + storage + financing = ~$70.70
5. Revenue: $71.50
6. Profit: $0.80/barrel (riskless)

Sophisticated traders exploit these missprices, keeping futures prices aligned with cost-of-carry.

Negative carry and backwardation

When convenience yield exceeds financing + storage, carry is negative. This creates backwardation: futures prices fall as you move forward in time.

Example: Oil crisis; immediate oil is scarce and commands a premium. Convenience yield (value of immediate supply) is $5/barrel. Financing + storage is $1/barrel. Net carry is -$4/barrel. Backwardated prices reflect this.

Stocks vs. commodities

Stocks: Cost of carry is mostly financing cost minus dividend yield. No storage or convenience yield.

Commodities: Cost of carry includes storage and convenience yield, creating contango or backwardation depending on supply-demand.

See also