cash-and-carry Basics

cash-and-carry Basics

Futures price = Spot Price + Carry Cost - Carry Return
F = S + CC - CR

Carry cost (CC) is the interest cost of holding the underlying asset (purchased in spot market) until the maturity of futures contract. Carry return (CR) is the income (eg, dividend) derived from underlying asset during holding period. Thus, the futures price (F) should be equal to spot price (S) plus carry cost minus carry return. If it is otherwise, there will be arbitrage opportunities as follows.

When F > (S + CC - CR): Sell the (overpriced) futures contract (sanjay: you have to buy it first to be able to seel it ! sel-short ? shorting future contact is allowed ?), buy the underlying asset in spot market and carry it until the maturity of futures contract. This is called "cash-and-carry" arbitrage.

When F < (S + CC - CR): Buy the (under priced) futures contract, short-sell the underlying asset in spot market and invest the proceeds of short-sale until the maturity of futures contract. This is called "reverse cash-and-carry" arbitrage.

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