What Is a Cash-and-Carry Trade?

A cash-and-carry trade is an arbitrage strategy that exploits the mispricing between an asset and its corresponding derivative. The ke𓆏y to profiting from this strategy is🐈 the eventual correction of that mispricing.

A cash-and-carry trade should not be confused with a carry trade in the context of forex trading, which lookཧs for interest rate differentials between countries.

Understanding Cash-and-Carry Trades

A cash-and-carry trade takes advantage of market pricing discrepancies. It usually entails taking a 澳洲幸运5官方开奖结果体彩网:long position in a security or commodity while simultaneously selling the associated derivative, specifically by shorting a futures or options contract.

The security or commodity being purchased is held until the contract 澳洲幸运5官方开奖结果体彩网:delivery date and is used to cover the short position’s obligation. By selling a futures contract, the investor has taken a short position. The investor knows how much will be made on the delivery date and the cost of the security because of the cash-and-carry trade’s long position component.

For example, in the case of a bond, the investor receives the coupon payments from the bond they've bought, plus any 澳洲幸运5官方开奖结果体彩网:investment income earned by investing the coupons, as well as the predetermined future price at the future delivery date.

Steps in a Cash-and-Carry Trade

There are three main step🌠s in a🐈 cash-and-carry trade:

• An investor identifies two securities that are currently mispriced with respect to each other, such as the spot crude price and crude futures price. This presents an 澳洲幸运5官方开奖结果体彩网:arbitrage opportunity.
• The investor must first purchase spot crude and sell a crude futures contract.
• Then, the investor must hold (or "carry") spot crude until the crude futures contract expires, at which time the investor delivers the spot crude.

Regardless of what the delivery price is, a profit is only assured if the purchase price of spot crude plus the 澳洲幸运5官方开奖结果体彩网:cost of carry is less than the price at which the☂ crude futures contract was initially sold.

Cash-and-Carry ♏Trades in the Credit Derivative💯s Market

This strategy is commonly known as 澳洲幸运5官方开奖结果体彩网:basis trading, Often, carry trades are exe🍸cuted to take advantage of the implied interest rates generated from the positions because they may end up being more favorable than borrowing or le🥃nding through traditional channels.

This strategy also has an application in the 澳洲幸运5官方开奖结果体彩网:credit derivatives market, where basis (the difference between a commodity's immediate cash price and its futures price) represents the difference in spread between 澳洲幸运5官方开奖结果体彩网:credit default swaps (CDS)  and bonds for the same debt issuer (and with similar—if not exactly equal—maturities).

Here, the strategy is called a negative basis trade. (In the credit derivatives market, basis can be positive or negative; 澳洲幸运5官方开奖结果体彩网:a negative basis means that the CDS spread 🐷is smaller than the bond spread.)

The trade is usually done with bonds that are trading at par or at a discount, and a single-name CDS (as opposed to an index CDS) of a tenor equal to the maturity of the bond.

Cash-and-Carry Trades in the Options Market

In the options market, an example of a carry trade is a 澳洲幸运5官方开奖结果体彩网:box spread.

Box spreads are used for borrowing or lending at implied rates that are more favorable than a trader going to their prime broker, clearing firm, or bank. Because the price of a box at its expiration will always be the distance between the strikes involved (e.g., a 100-pt box might utilize the 25 and 125 strikes and would be worth $100 at expiration), the price paid for today can be thought of as that of a 澳洲幸运5官方开奖结果体彩网:zero-coupon bond.

The lower the initial cost of the 🅘bo♋x, the higher its implied interest rate.

This concept is known as a synthetic loan. Thus, the difference in the price of the box spread from the difference between the strike prices is the carry♔.

For instance, if a trader executes a carry trade using a box spread in the S&P 500🌃 using 🐲the 1,000 and 2,000 strikes, the spread will be worth $1,000 at expiration (i.e., the distance between strikes). If the spread costs $1,050 in the market, that $50 represents the implied interest rate associated with the cost of carry.

Example of a Cash-and-Carry Trade

Assume an asset currently trades at $100 while the one-month futures contract is priced at $104. In addition, monthly 澳洲幸运5官方开奖结果体彩网:carrying costs—such as storage, insurance, and financing—for this asset is equal to $2.💎 In this case,✱ the trader would buy the asset (open a long position) at $100, and simultaneously sell the one-month futures contract (initiate a short position) at $104.

The cost to buy and hold the asset is $102, but the investor has already locked in a sale at $104. The trader would then carry the asset until the expiration date of the futures contract and deliver it against the contract, thereby ensuring an arbitrage profit of $2.

The Bottom Line

The cash-and♎-carry trade is one variety of arbitr🤪age, the practice of buying and selling the same asset in two markets in order to profit from the brief discrepancies in their prices.

The practice of arbitrage is perhaps best🌟 known in the currency markets, where miniscule differences in posted prices encourage such a strategy.

Cash-and-carry, though, relies on a different set of assets: one the "real" asset and a second a derivative based on that asset's price.