Definition
Cost of Carry
Cost of carry is the net cost of holding an asset to a future date, comprising financing cost less any income, and it determines the fair-value difference between a futures price and the underlying spot price.
For Indian equity futures, the theoretical fair value of a future equals the spot price plus the cost of carry (interest on funds) minus expected dividends until expiry. When the actual futures price deviates from this, cash-futures arbitrage brings it back, so cost of carry anchors the basis.
The observed basis, futures minus spot, reflects the market-implied cost of carry and can signal sentiment: a high positive basis suggests bullish leverage demand, while a negative basis can indicate bearishness or dividend effects. Arbitrageurs profit when the basis strays from the true carry.
Related terms
- Market-Neutral StrategyA market-neutral strategy balances long and short positions so that the portfolio has little or no net exposure to broad market movements, isolating the manager's stock-selection skill.
- Index ArbitrageIndex arbitrage exploits price differences between an index's futures and the basket of its underlying stocks (or an ETF), buying the cheaper and selling the dearer to capture the convergence.
- Cash-Futures ArbitrageCash-futures arbitrage profits from the gap between a stock's cash price and its futures price relative to fair value, capturing the cost-of-carry by holding the cash position against an offsetting futures position.
- Basis (Futures)Basis is the difference between the futures price and the spot price of the underlying, reflecting the cost of carry and market expectations, and it converges to zero as the contract approaches expiry.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.