What It Means
Cost of Carry is the extra amount priced into a futures contract above the current spot price, to cover the cost of holding that position until expiry. It's mostly the interest you'd earn or pay on that money over the remaining time, adjusted for any dividends expected before the contract expires.
How It Works
A futures contract almost never trades at exactly the spot price. The exchange prices in the cost of carrying that position forward: interest cost, minus any dividend the underlying is expected to pay before expiry (a dividend effectively lowers the cost, since you'd have received it by holding the stock directly instead).
Futures Price = Spot Price + Cost of Carry
- Spot Price
- The current market price of the underlying index or stock
- Cost of Carry
- Interest cost of holding the position until expiry, minus expected dividends
A contract with more time left to expiry carries more cost, since interest accrues for longer. That's why a far-month contract usually trades higher than a near-month one on the same underlying, and both usually trade above spot.
Example
NIFTY spot is at ₹25,000, and the next-month futures contract is trading at ₹25,140. The ₹140 difference is the cost of carry priced into that one month, roughly 0.56% of the spot value for holding the position that long.
Warning
A gap between the futures price and spot price is normal and expected, not a sign of mispricing. Assuming futures should always trade at exactly spot value is a common mistake for traders new to F&O.
Related Terms
- Rollover: closing an expiring contract and opening the next one, where cost of carry is usually the biggest part of the cost
- F&O (Futures & Options): the contract types cost of carry applies to