What it means
The trade has two linked legs: the trader owns the asset now and owes the economic equivalent later through a short futures position. If futures are expensive relative to the all-in carry cost, convergence may offer a net spread.
For a warehouse commodity, buying spot means obtaining physical inventory, and carry includes financing the purchase, storing and insuring it. The futures contract specifies grade, location and delivery terms, which may not exactly match the inventory.
Some futures can be settled by delivery and others are cash settled, so a trader must understand how the spot asset and futures position will be linked or closed. Assuming that any asset can be delivered into any short contract is a serious operational mistake.
A simple example starts with a spot price of $100 and a futures sale at $104 for the same delivery date. If all financing and holding costs are $3, the net spread is $1 per unit ($104 - $100 - $3) before fees and remaining risks.
If actual costs reach $5, the illustration becomes a loss. Financing makes the position vulnerable, because a higher borrowing rate or a lender withdrawing funding can consume the expected spread, and borrowing to carry a low-margin opportunity magnifies both returns and stress.
Futures positions also require margin: if prices move against the short futures leg, the clearing system may demand additional collateral even when the cash asset has risen in value. The cash asset's gain may be hard to turn into immediate cash without disrupting the trade.
The Bank for International Settlements has discussed leveraged US Treasury cash-futures basis trades and their margin vulnerabilities, a warning that an apparently hedged price relationship can still create a funding squeeze. A desk should model cash calls, not just final payoff.
For stored commodities, carrying cost is not fixed by a spreadsheet, because storage capacity, insurance and handling costs can change, and CME's wheat materials explicitly relate nearby futures spreads to financial full carry and variable storage rates. Transaction costs matter in both legs: bid-ask spreads, exchange fees, brokerage, custody and taxes can erase a one-unit theoretical gain, so the right comparison uses executable prices, not two mid-market quotes displayed at different moments.
A strategy called market-neutral still has other exposures, since it may reduce directional price risk while increasing funding, margin, operational or counterparty risk. The practical test is to list the exact eligible asset, matching contract, dates and all cash flows, stress the funding rate, margin requirement and exit spread, and only then discuss a quoted futures premium as a potential opportunity.
In practice
Real-world examples.
Example
A grain trader buys a deliverable lot for $100 per unit and sells a matching future for $104. Financing, storage and insurance are expected to cost $3, leaving $1 before fees if the delivery assumptions hold.
Example
A bond fund buys a cash Treasury and shorts a related futures contract. The spread narrows eventually, but an interim margin call requires cash while the bond position remains in custody.
Example
A warehouse charge rises after a trader establishes a wheat trade. The new cost erases the spread that appeared attractive when the two legs were priced.
Formula
Calculation
Simplified expected spread per unit = executable futures sale price - executable spot purchase price - financing cost - storage and insurance - fees and delivery adjustments. At $104 minus $100 minus $3, the starting spread is $1 before omitted costs. A positive estimate is not a guaranteed final profit.
Scaled up, a lot of 5,000 units earns 5,000 x $1 = $5,000 on paper. If fees and a slightly higher storage rate add $0.40 per unit, the spread falls to $0.60 and the lot earns 5,000 x $0.60 = $3,000, so small cost changes remove 40% of the expected profit.Case study
Seen in the real world.
Fictional example: Mariam's trading desk saw a premium between a cash bond and its futures contract. An analyst estimated an attractive spread using the quoted midpoint and the desk's usual funding rate. Mariam checked executable prices, the futures delivery option and a scenario with a higher margin requirement. The revised spread was small, and the desk could not fund a large margin call without selling bonds. It reduced the planned position rather than calling the initial screen gap free money.
Watch out
Common mistakes.
- Treating the quoted spot-futures difference as profit before financing, storage, fees and delivery adjustments.
- Calling the position riskless while ignoring cash margin calls and the possibility of funding withdrawal.
- Assuming the purchased asset matches the futures contract's grade, location or conversion terms without checking.
Questions
People also ask.
What are the two legs?
A long cash or spot asset and a short related futures contract, with settlement or offset planned under the contract's terms.
Is cash-and-carry guaranteed arbitrage?
No. A theoretical price gap may be consumed by carry costs, execution, margin demands, basis mismatches or funding problems.
Why can a hedged desk need cash?
A short futures leg can generate margin calls before the cash asset's value is realised or the prices converge.
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