Cash and Carry is an arbitrage strategy that involves buying an asset in the spot market and simultaneously selling a futures contract on the same asset.
In finance, an arbitrage strategy refers to a trading technique where a trader seeks to profit from price differences for the same asset in different markets. The idea is to buy the asset in one market where the price is lower and sell it in another market where the price is higher, thereby making a profit from the price difference.
The spot market is a market where financial instruments, such as currencies, commodities, and securities, are traded for immediate delivery, or “on the spot”. In the spot market, the price of an asset is determined by supply and demand factors, and the transaction is settled immediately or within a short period of time, typically two business days.
The futures market is instead a market where participants can trade futures contracts for a variety of underlying assets, such as commodities, currencies, interest rates, and stock indices. A futures contract is a standardized agreement between two parties to buy or sell an underlying asset at a predetermined price and date in the future. In the futures market, the price of the futures contract is determined by the market’s expectation of the future price of the asset.
The goal of the strategy is to profit from the price difference between the spot price of the asset and the price of the futures contract: if the futures price is higher than the spot price, it creates an opportunity for traders to profit by buying the asset in the spot market and selling it in the futures market. The profit is equal to the difference between the two prices, minus any transaction costs or financing costs incurred in the process.
The cash and carry strategy involves three main steps. First, the trader buys the underlying asset in the spot market. This could be a physical commodity such as gold, oil, or wheat, or a financial asset such as a stock or bond. Second, the trader simultaneously sells a futures contract for the same asset. This locks in the price of the futures contract and creates an obligation to deliver the asset at a future date. Finally, the trader holds the asset until the futures contract expires, at which point they deliver the asset to fulfill the obligation.
One of the advantages of the cash and carry strategy is that it allows traders to profit from the price difference between the spot market and the futures market without taking on significant price risk. Since the trader has locked in the price of the futures contract at the time of the trade, they are protected against any adverse price movements in the future.
Another advantage of the cash and carry strategy is that it allows traders to take advantage of financing opportunities. Since the trader is buying the asset in the spot market and holding it until the futures contract expires, they may be able to finance the purchase at a lower rate than the cost of financing the futures contract. This can create a positive carry, where the income from holding.
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