Cash and Carry Transaction - Explained
What is a Cash and Carry Transaction?
Written by Jason Gordon
Updated at October 2nd, 2021
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Table of Contents
What is a Cash and Carry Transaction?How Does a Cash and Carry Transaction Work?Example of a Cash and Carry TransactionWhat is a Cash and Carry Transaction?
A cash and carry transaction is also known as a cash and carry arbitrage, this transaction applies to the trade of derivative products or futures contract. In a cash and carry transaction, the price of a commodity is lower than the futures contract price. Cash and carry arbitrage involves the purchase of an underlying asset in a futures contract, in which the asset is held throughout the arbitrage duration. Purchase in a cash and carry transaction is done either with cash or in the spot market.
Back to: INVESTMENTS TRADING & FINANCIAL MARKETS
How Does a Cash and Carry Transaction Work?
Cash and carry transaction is otherwise called basis trading, traders participate in this type of trade to leverage the difference between the price of an underlying commodity in a futures contract and the futures contract price. As an arbitrage strategy, cash and carry trade is profitable to a buyer when the amount paid as the purchase price and cost of carrying of the asset is lower than the futures contract price. Traders who participate in arbitrage deals do so to take advantage of the variance in the prices of similar assets and commodities in various markets. Differences in the price of commodities across varying markets do not last for long because they occur due to market inefficiencies and are fixed once they are noticed.
Example of a Cash and Carry Transaction
The example below will enhance a better understanding of a cash and carry transaction; If the stock of Company A is trading on the stock exchange at $50 but the same stock is listed on a futures exchange at $80, a market trader can buy such stock on the spot, rather than buying in the future, thereby making a profit of $30. Once the trader purchases the Company stock at that spot, the stock must be held until expiration before it is delivered. Usually, arbitrage transactions yield significant profits with little or no risk incurred by a trader. The difference in the price of an underlying asset and the futures contract price often occurs as a result of market inefficiencies. Given that market inefficiencies do not often occur, it is quite difficult to come across cash and carry arbitrage.