What is Cash and Carry Trade in Finance?

Cash and carry trade is a transaction in which a buyer takes a short position on a futures contract and a long position on the underlying asset, where the current price or spot price of the underlying commodity falls below the price in the futures contract. Profiting from a cash and carry trade is considered as a type of arbitrage where a trader uses the cash and carry trade method to make money from uncertainties or inefficiencies in the market. The trader does this with regard to the buying basis.

Understanding cash and carry trade

Cash and carry trade (also known as “carry trade”) is a trading strategy investors use to take advantage of market pricing inconsistencies. In this trading strategy, the security being purchased will be held until the contract delivery date, to cover the short position’s obligation. When the trader or investor sells a futures contract they have taken a short position and knows approximately how much will be made on the delivery date and the cost of the security or commodity.

The arbitrage strategy of cash and carry is done when an investor feels that the securities involved are mispriced with regard to each other. The mispricing will only be corrected when the gain on one side of the trade cancels out the loss on the other side of the trade like in the case of a trade taking place on a security and futures contract. The trade becomes profitable if the purchase price plus the cost of carry is lower than the futures price.  

Cash and carry trade strategy can be easily broken down into the following steps:

• An investor identifies two securities or commodities that are mispriced with regard to each other, which presents an arbitrage opportunity. For example, spot gold price and futures gold price.

• The investor goes ahead to purchase the spot gold and sell and gold futures contract then “carry” or hold spot gold until the gold futures contract expires, the time he delivers the spot gold.

• If the purchase price of the spot gold plus the cost of the carry is less than the price at which the gold futures contract was initially sold, the investor will make a profit.