Cost of Carry: Futures Discovery EP 8

For futures traders, understanding the cost of carry is fundamental to making informed trading decisions. The cost of carry in futures trading refers to the expenses incurred for holding a futures contract over time, including interest rates, storage costs, and other factors. In this blog post, we’ll explore the intricacies of cost of carry and how it impacts futures pricing dynamics.

Futures Pricing Dynamics: Contango and Backwardation

Futures markets can exist in two states: contango and backwardation. These scenarios are determined by the relationship between spot prices and futures prices.

Contango Market Scenario

In a contango market, futures prices are higher than spot prices. This situation arises when the cost of carry is positive, indicating that holding the underlying asset is more expensive than buying it in the future. Contango markets can impact futures trading strategies, as it may be more profitable to sell futures contracts and buy the underlying asset.

Backwardation Market Scenario

Conversely, a backwardation market occurs when futures prices are lower than spot prices. This happens when the cost of carry is negative, suggesting that holding the underlying asset is less expensive than buying it in the future. Backwardation markets can create opportunities for futures market arbitrage, as traders can buy futures contracts and simultaneously sell the underlying asset for a profit.

Factors Influencing Cost of Carry in Futures Markets

Several factors can influence the cost of carry in futures markets, including:

  • Interest Rates: Higher interest rates increase the cost of financing futures positions, impacting the cost of carry and potentially leading to futures contract rolling.
  • Storage Costs: For physically settled futures contracts, storage costs can significantly affect the cost of carry, particularly in markets with high volatility.
  • Convenience Yield: The convenience yield represents the benefit of holding the underlying asset, which can offset the cost of carry. This factor is crucial in futures spread trading.

 

FAQ (Frequently Asked Questions)

What is the cost of carry in futures trading?

The cost of carry in futures trading refers to the expenses incurred for holding a futures contract over time, including interest rates, storage costs, and other factors. It represents the difference between the spot price and the futures price of an underlying asset.

How does the cost of carry impact futures pricing?

The cost of carry directly influences futures pricing. When the cost of carry is positive (contango), futures prices are higher than spot prices. When the cost of carry is negative (backwardation), futures prices are lower than spot prices. Understanding the cost of carry helps traders make informed decisions and identify potential arbitrage opportunities.

What strategies can traders use to manage the cost of carry?

Traders can employ various strategies to manage the cost of carry, such as:

  • Spread trading: Taking advantage of price differences between two related futures contracts
  • Rolling contracts: Moving positions from an expiring contract to a new one to maintain market exposure
  • Arbitrage: Exploiting price discrepancies between the spot market and futures market

By understanding and effectively managing the cost of carry, futures traders can make more informed decisions, maximize profits, and minimize risks in the dynamic futures market landscape.

Sponsor

A black and white image of a plane flying in the sky.

HOST

A young man in a white polo shirt standing in front of a purple background.

Corties Draper

Roosevelt University student, CBOT Clearing Corporation Foundation Honors Fellow and captain of the Roosevelt football team

Full Episodes

Algorithmic Adventures: Futures Discovery EP 11

Algorithmic Adventures: Futures Discovery EP 11

In episode 11 of Futures Discovery, we’re immersing ourselves in a pivotal episode focused on Algorithmic Adventures: Navigating the World of Order Book Strategies in Futures Trading. It’s not merely about numbers and charts; it’s about deciphering the dynamic landscape of financial trading. Join us as we delve into the intricacies of reading your statement as a professional in the futures market and unravel the secrets behind successful algorithmic strategies.

PAST SPREAD EPISODES

Algorithmic Adventures: Futures Discovery EP 11

Algorithmic Adventures: Futures Discovery EP 11

In episode 11 of Futures Discovery, we’re immersing ourselves in a pivotal episode focused on Algorithmic Adventures: Navigating the World of Order Book Strategies in Futures Trading. It’s not merely about numbers and charts; it’s about deciphering the dynamic landscape of financial trading. Join us as we delve into the intricacies of reading your statement as a professional in the futures market and unravel the secrets behind successful algorithmic strategies.

The role of the FCM: Futures Discovery EP 10

The role of the FCM: Futures Discovery EP 10

In episode 10 of Futures Discovery, we’re immersing ourselves in a detailed exploration of the pivotal role of Futures Commission Merchants, commonly known as FCMs. These financial intermediaries play a crucial role in facilitating futures and options trading, serving as a linchpin in the complex web of derivative markets. Understanding the intricate responsibilities and functions of FCMs is essential for navigating the dynamic landscape of modern financial systems.

Contango: Futures Discovery EP 9

Contango: Futures Discovery EP 9

In episode9 of Futures Discovery, we explore the fascinating world of futures trading, focusing on a concept called contango. In this episode, Cortez explains why futures prices for commodities, like oil, can be higher in the distant future compared to the near future. We’ll look into the costs of holding physical assets, like storage and insurance, and how these costs affect futures prices. Whether you’re an experienced investor or new to the futures market, this episode offers valuable insights.

Pin It on Pinterest

Share This Story