Any costs that are related to the value of carrying an investment are called costs of carry. The cost of carry of, say, a loan, may be the interest charged to you. In another instance, the cost of carry may be interest on a margin account. The term ‘cost of carry’ also includes costs by opportunity linked with moving from one position to another. Referring to derivatives markets, the term stands to be a vital factor to consider for value generation related to the future price of an asset.
Simply put, when you have to spend any additional funds to maintain a particular position, those are the costs of carry. It's important that you fully understand the term if you are to trade in the stock market. In the arena of financial markets, cost of carry is a factor that requires thinking about, as it varies depending on any costs related to holding a specific position or a stock. For instance, across markets, cost of carry futures may be ambiguous. This has crucial bearing on the demand for trading and may be the source of opportunities for arbitrage even. Trading in stocks involves cost of carry as you may be charged fees while trading per share.
Cost of carry definition in the futures market of derivatives is in the form of a part of the calculation for future cost of a stock. If cost of carry is linked to a physically held commodity, expenses that include storage rates, inventory prices, and insurance may be the cost of carry incurred by an investor. Furthermore, every investor is different and may have their individual cost of carry factors influencing them to purchase in futures markets at various prices. The price calculation of the future’s market also considers what is called ‘convenience yield’. This is a benefit in terms of value of actually having the commodity in question. Here is the cost of carry formula:
Broken down where:
From this model, you can see how different factors relate to each other to influence the price of a future asset.
Looking beyond commodity markets, in other markets, different scenarios may prevail. Different markets possess their own models to calculate and assess prices of stocks. Suffice it to say that when you are trading in stocks or commodities, you will have to incur some cost of carry. You should be aware how much that amount involves as this can affect your net return. For instance, in online stock trading, your net profit may be adversely impacted as charges of holding a stock may be more than the profit you’d make.
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