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Cash and Carry Trade Strategy

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Written By
Dan Buckley
Contributor Image
Written By
Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.
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Updated
Dec 8, 2022

What Is a Cash and Carry Trade Strategy?

A cash and carry trade is a type of price arbitrage strategy in which an investor buys an asset and simultaneously sells a futures or derivatives contract for the same asset, or vice versa.

The goal of this strategy is to profit from the difference between the asset’s spot price and the price at which the futures contract is sold.

This strategy is often used when an investor believes that the spot price of an asset will increase in the future, allowing them to profit from the difference between the two prices.

The cash and carry trade strategy can be used in a variety of market conditions, but it is typically most effective when the spot price of the asset is lower than the futures price (or vice versa).

The profit from the strategy is achieved when the prices of the two converge.

 

Cash and Carry Trade Strategy – Key Takeaways

  • It is a market-neutral strategy that aims to profit from discrepancies between the prices of a security and asset and its corresponding futures contract.
  • The strategy involves buying the underlying and simultaneously selling its corresponding futures contract.
  • It is typically used in markets where the futures contract is trading at a premium to the underlying stock.
  • The potential profit from this strategy is limited by the costs associated with carrying the underlying stock, such as financing and storage costs.
  • The strategy can be used in a variety of market conditions, but is most effective when the futures contract is trading at a high premium to the underlying stock.

 

Is the Cash and Carry Trade Strategy the Same As a Regular Carry Trade Strategy?

The cash and carry trade strategy is similar to a regular carry trade strategy, but there are some key differences between the two.

A regular carry trade involves buying an asset and holding it for an extended period of time in order to profit from the difference between the asset’s interest rate and the interest rate of the borrowed funds used to buy the asset.

This strategy is typically used when the interest rate of the asset is higher than the interest rate of the borrowed funds, allowing the investor to earn a positive carry, or profit.

In contrast, the cash and carry trade strategy involves buying an asset and simultaneously selling a futures contract for the same asset.

The goal of this strategy is to profit from the difference between the spot price of the asset and the price at which the futures contract is sold.

This strategy is often used when an investor believes that the spot price of the asset will increase in the future, allowing them to profit from the difference between the two prices.

 

What Is an Example of the Cash and Carry Trade Strategy?

An example of the cash and carry trade strategy is as follows:

  1. A trader believes that the price of crude oil will increase in the future, so they decide to implement the cash and carry trade strategy.
  2. The trader buys 1,000 barrels of crude oil at the current spot price of $50 per barrel, for a total cost of $50,000.
  3. The trader simultaneously sells a futures contract for 1,000 barrels of crude oil at a price of $55 per barrel (i.e., the futures price for crude oil at some point in the future).
  4. The trader holds onto the crude oil and waits for the futures contract to expire.
  5. If the price of crude oil increases to $60 per barrel when the futures contract expires, the trader will be able to sell their crude oil for a profit of $10,000 ($60 per barrel – $50 per barrel = $10 per barrel, and 1,000 barrels x $10 per barrel = $10,000).
  6. The trader will lose $5,000 on the futures contract ($55 per barrel – $60 per barrel = minus-$5 per barrel, and 1,000 barrels x minus-$5 per barrel = minus-$5,000).
  7. In total, the trader will earn a profit of $5,000 from their cash and carry trade strategy ($10,000 from the increase in the spot price of crude oil, and a $5,000 loss from the difference between the futures contract price and the spot price).

Of course, this is just an example and the actual outcome of a cash and carry trade strategy will depend on the specific market conditions and the investor’s individual investment decisions.

 

Is the Cash and Carry Trade Strategy the Same As Basis Trading?

Yes, basis trading is essentially the same as the cash and carry trade strategy, as it involves buying an asset and simultaneously selling a futures contract for the same asset.

The goal of basis trading is to profit from the difference between the spot price of the asset and the price at which the futures contract is sold.

 

Cash And Carry Trades

 

Cash and Carry Trade Strategy Example in the Credit Markets

An example of the cash and carry trade strategy in the credit or bond markets is as follows:

  1. A trader believes that 10-year US Treasury bonds are mispriced relative to the futures price (e.g., prices will rise and yields will fall), so they decide to implement the cash and carry trade strategy.
  2. The trader buys $100,000 worth of 10-year US Treasury bonds at a yield of 3.5%.
  3. The trader simultaneously sells a futures contract on 10-year US Treasury bonds at an implied yield of 3.0% (i.e., they’re at a higher price than the spot price), which is the current futures yield for these bonds.
  4. The trader holds onto the bonds and waits for the futures contract to expire.
  5. If the yield on 10-year US Treasury bonds decreases to 3.0% when the futures contract expires, the trader will be able to sell their bonds for a profit.
  6. The trader will also be able to profit from the difference between the futures contract yield and the spot yield of the bonds, earning an additional profit.
  7. In total, the trader will earn a profit from their cash and carry trade strategy.

 

Cash and Carry Trade Strategy Example in the Options Markets

Traders will often buy options as a way of – when relevant – avoiding the borrowing costs associated with buying the underlying.

Let’s say a trader wants to own a box spread of SPY between the 400 and 500 call strikes out one year.

The value between the two strikes is $10,000 ($100 * 100 shares per options contract). If the cost of the spread is $10,400, that implies a 4 percent interest rate.

If that’s lower than the borrowing rate from the broker (or a different funding source), then the trader may prefer putting the trade on through the options market because of this cheaper funding.

 

FAQs – Cash and Carry Trade Strategy

What Is Cash and Carry Arbitrage?

Cash and carry arbitrage is a trading strategy that involves buying an asset, such as a stock or commodity, and simultaneously selling a related financial instrument, such as a futures contract, in order to profit from the difference in the price of the two assets.

This type of arbitrage takes advantage of price discrepancies between the cash market and the futures market to generate a profit without taking on significant risk.

For example, if the price of a stock index is lower in the cash market than the price of the corresponding futures contract, an investor could buy the stock index and sell the equivalent futures contract to profit from the difference in prices.

What Is Reverse Cash and Carry Arbitrage?

Reverse cash and carry arbitrage is a trading strategy that is similar to cash and carry arbitrage, but involves selling an asset in the cash market while also buying a related financial instrument (hopefully the same thing as to not proxy trade), such as an equivalent futures contract, in order to profit from the difference in prices.

This strategy is often used when the price of an asset is higher in the cash market than the price of the corresponding futures contract.

For example, if the price of a stock is higher in the cash market than the price of the corresponding futures contract, a trader could sell the stock and buy the futures contract and be able to profit from the difference in prices.

What Factors Should Traders and Investors Consider When Implementing a Cash and Carry Trade Strategy?

When implementing a cash and carry trade strategy, traders and investors should consider factors such as the liquidity of the markets involved, the amount of capital available for the trade, and any applicable regulations or restrictions.

They should also be aware that there may be additional costs associated with transacting in multiple markets for this type of arbitrage strategy. Commissions and other transaction costs (i.e., the bid-ask spread) will apply.

Finally, investors should ensure that they fully understand how this type of arbitrage works before attempting to implement it.

What Is Margin Trading?

Margin trading is a type of trading in which investors borrow money from a broker or other lender to purchase assets more expensive than their own capital would allow them to do.

This type of trading allows an investor to leverage their own capital by borrowing funds from the broker or lender, thus increasing the potential return on investment but also increasing the potential for losses if the asset does not perform as expected.

 

Conclusion – Cash and Carry Trade Strategy

The cash and carry trading strategy is a market-neutral strategy that seeks to profit from discrepancies between the prices of a stock and its corresponding futures contract.

This strategy can be used to generate profits by buying an asset in the cash market and simultaneously selling a related instrument, such as a futures contract, or by selling an asset in the cash market and simultaneously buying a related instrument.

This strategy can be used in a variety of market conditions, but is most commonly employed in markets where the futures contract is trading at a premium to the underlying stock.

However, investors should understand all risks associated with this type of trading before attempting to implement it.

Additionally, they should consider factors such as liquidity, capital available for the trade, and any applicable regulations or restrictions when utilizing this strategy.

Investors who are considering using the cash and carry trade strategy need to be aware of all risks associated with the strategy and make sure they understand how it works before attempting to implement it.

By doing so, investors can ensure that they are able to maximize their profits while minimizing their risk.