What Is Cost Of Carry And How It Is Calculated?

New Delhi: Cost of Carry or COC is the cost of an investor to hold certain positions in the underlying market until the futures contract expires.

This cost includes the risk-free interest rate and the dividend payment from the underlying is excluded from the COC. The COC is the difference between the futures and the spot price of a stock or index.

Cost of carry is important because the higher the value of COC higher will be the willingness of traders to pay more money to hold futures.

How COC IS Calculated?

Formula:

Futures price = Spot price + cost of carry

Or cost of carry = Futures price – spot price

COC is calculated as an annualized rate and is expressed in percentage values. Real-time COC values are available on stock exchange websites.

Suppose the spot price of X scrip is Rs 1,600 and the prevailing interest rate is 7 per cent per annum. Therefore the futures price of a one month contract would be:

1,600 + 1,600*0.07*30/365 = Rs 1,600 + Rs 11.51 = 1,611.51

Here, the cost of carrying is Rs 11.51.

How Is It Interpreted?

The value of COC is used as an indicator to understand the sentiment of the market i.e. a low COC means that the value of the underlying has declined and vice versa.

Markets That Are Affected By Cost Of Carry

There are two main markets called foreign exchange and commodities that are most affected by the cost of carry. However, other financial products such as derivatives are also affected by the cost of carry.

Each of these markets elicits different forms of cost of carrying.

Cost of Carry Can Be Negative?

Yes. When futures trade at a discount to the underlying, the resulting cost of carry is negative. This usually happens for two reasons: when the stock is expected to pay dividends, or when traders are aggressively executing a "reverse arbitrage" strategy, which involves buying spots and selling futures. The negative cost of carry marks bearish sentiment.

Also read: What Is GDP And How It Is Calculated?

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