Carrying Charge - Explained
What is a Carrying Charge?
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Table of ContentsWhat is a Carrying Charge?What is included in the Carrying Charge?Carry Charge Arbitrage Example
What is a Carrying Charge?
Carrying charge, also referred to as the cost of carry, these costs include insurance fees, storage costs, interest charges, and others. These charges refer to an amount of money incurred as a result of holding property, interest rates, storage costs, and other fees over a specific period of time.
What is included in the Carrying Charge?
The cost of holding physical commodities for retail investors can be at their disadvantage as storage and insurance charges are much. This will prompt these retail investors and other investors to consider commodity exchange-traded funds. Carrying charges are usually included in the price of a commodity futures or forward contract. Usually, the price of a commodity for delivery in the future should be the same its spot price and the carrying charge but as a result of unfavorable conditions caused by different factors or other developments, the arbitrage opportunity may take place.
Carry Charge Arbitrage Example
Carry charge Arbitrage is a market strategy that combines the buying and sale of a position in an asset on the underlying asset. Such assets may include stock, commodity and others. For example, the spot price of a commodity is $50 per unit. The one-month carrying charge is $2, while the one-month futures price is $55. An arbitrageur could earn a profit of $3 per unit in this case by purchasing the commodity at the spot price and storing it for a month, if the arbitrageur decides to sell the commodity for delivery in a month at the one-month futures price. This process is known as cash-and-carry-arbitrage. This trading strategy is deployed in the oil industry if oil prices in the future rise above the present price. In other words, tanker freight rates are fair and the futures curve is high. This strategy as used in the oil industries implies that the oil producer buying oil and storing it for a specific time frame. When they decide to sell it, if the charge rates for keeping the oil is low, they make a huge profit selling other than selling on the spot.