What it means
Every asset you hold has a running cost, even when no invoice arrives. The clearest component is financing: money spent on the asset is money not earning interest elsewhere, so the interest rate is a genuine cost of ownership.
Add storage and insurance for physical goods, and subtract dividends, coupons or lease income for financial assets. The concept links spot and futures prices.
If holding gold for a year costs 5.5% all in, then a futures contract for delivery in a year should trade about 5.5% above the spot price, otherwise a trader could buy the metal, sell the future and lock in a risk-free profit. That relationship is called cost-of-carry pricing and it holds well for storable assets with deep markets.
When the futures price sits above spot the market is in contango, and when it sits below spot it is in backwardation. Contango is the normal state for a commodity with real storage costs.
Backwardation signals that holders value having the physical goods now, an advantage traders call the convenience yield, which acts as a reduction in carry. Outside commodity markets the same idea appears constantly.
Holding inventory carries warehouse, insurance, obsolescence and financing costs; holding a leveraged share position carries margin interest less dividends received; holding foreign currency carries the interest rate differential between the two currencies. In each case the question is identical: what does one more month of holding this cost me?
The nuance that trips people up is that a positive cost of carry is not automatically bad. If an asset is expected to appreciate by more than the carry then holding it still makes sense, and a negative carry position can still lose money if the price falls.
Cost of carry sets the hurdle a position has to clear, not the outcome.
In practice
Real-world examples
Example 1
A grain merchant buys wheat at harvest for $220 per tonne, pays $9 per tonne for six months of storage and insurance, and finances the purchase at 6% a year, costing about $6.60 per tonne over the period. The six-month carry is roughly $15.60, so the merchant will only store the grain if the forward price exceeds about $235.60 per tonne.
Example 2
An electronics distributor calculates that holding stock costs 18% a year once warehousing, insurance, financing and obsolescence are included. On average inventory of $4,000,000 that is $720,000 a year, which justifies a project to cut average stock by a quarter and save around $180,000 annually.
Example 3
A currency trader holds a position long a higher-yielding currency and short a lower-yielding one, earning the interest rate differential each night. The carry is positive at about 3% a year, but a 4% adverse move in the exchange rate over a few weeks wipes out more than a year of that income.
Think of it
Imagine owning a horse. The purchase price is just the start. You also have to pay every single month for stable rent, feed, and veterinary care. Those ongoing upkeep expenses are your cost of carrying the horse.
Formula
Calculation
Formula: Cost of carry = Financing cost + Storage and insurance - Income earned, and for a one-year horizon, Fair futures price = Spot price x (1 + carry rate)
Worked example. A refiner holds 1,000 ounces of gold with a spot price of $2,000 per ounce, so the position is worth 1,000 x $2,000 = $2,000,000. Financing costs 5% a year, storage plus insurance costs 0.5% a year, and the metal earns no income.
Carry rate: 5% + 0.5% = 5.5%.
Annual carry cost on the position: $2,000,000 x 0.055 = $110,000, which is $110,000 / 1,000 = $110 per ounce.
Fair one-year futures price: $2,000 x 1.055 = $2,110 per ounce.
Now suppose the one-year future is quoted at $2,150. A trader can buy gold at $2,000, sell the future at $2,150, carry the metal for $110 and deliver it, locking in $2,150 - $2,000 - $110 = $40 per ounce, or $40,000 across 1,000 ounces. That gap is exactly what arbitrage closes, which is why quoted futures prices usually sit very close to the carry-implied level.Case study
Seen in the real world
The following is an illustrative and fictional example. Thornbury Metals, an invented trading company, bought 5,000 tonnes of refined copper at $8,000 per tonne, a position worth $40,000,000, expecting prices to rise over the following twelve months.
In this fictional scenario the carry was calculated carefully before the trade. Financing at 6% cost $2,400,000 a year, warehousing and insurance at $60 per tonne cost $300,000, and there was no income from holding the metal, giving a total annual carry of $2,700,000, or $540 per tonne. That meant copper had to reach $8,540 per tonne within a year simply for the position to break even.
Twelve months later the price in this invented case had risen to $8,400. The trading desk reported a $2,000,000 gain on the metal, since 5,000 x $400 = $2,000,000, but after the $2,700,000 carry the position had lost $700,000. The lesson the illustrative company drew was to quote every commodity view as a required price change including carry, rather than as a directional opinion, so that the hurdle was visible before the trade rather than after it.
Watch out
Common mistakes
- Counting only out-of-pocket costs such as storage. Financing, or the return given up on the money tied into the asset, is usually the largest single component of carry.
- Assuming contango means the market expects higher prices. A futures curve sloping upwards mostly reflects the cost of carrying the asset to the delivery date, not a forecast.
- Ignoring carry when judging whether a trade or a stockholding worked. A position can show a gain on price and still lose money once the cost of holding it is deducted.
Questions
People also ask
What is a negative cost of carry?
It arises when the income from holding an asset exceeds the financing and storage costs, as with a high-dividend share funded at a low interest rate, so you are paid to hold the position.
How does convenience yield fit in?
It is the benefit of having physical goods on hand, such as being able to keep a factory running, and it offsets carry costs, which is why markets short of supply can move into backwardation.
Does cost of carry apply to inventory in an ordinary business?
Yes, and it is often the clearest use of the idea, since the annual cost of holding stock commonly runs between 15% and 25% of its value once financing, space, insurance and obsolescence are added.