What is a carrying charge? 

A carrying charge is the cost of holding a physical commodity or financial asset over a period of time until a future date.

How carrying charges work 

High carrying charges increase the costs of an investment which places downward pressure on an investments expected return.  In futures pricing, carrying charges often increase the futures price above the spot price, which also lowers the effective expected return unless compensated by price movements or convenience yield

Since carrying charges are the costs associated with holding a position in a physical commodity or financial asset over time until the delivery or settlement. They represent all the costs incurred for holding an asset until a future date. The components include storage costs, insurance costs, financing, security, and regulatory fees. However not all assets carry storage or insurance, in equities financing costs (margin interest) apply.

Where carrying charges apply 

Carrying charges, in an investment context, are the expenses associated with holding an asset over a period of time. These charges can apply to various types of investments and assets. Common examples include the costs of storing crude oil, real estate carrying costs (mortgage, taxes, insurance), and inventory holding expenses. In capital markets the carrying charges primarily relate to the cost of borrowing funds to hold a position or the cost the broker charges you for buying a stock on margin or leverage rather than physical storage.

Types of carrying charges 

There are various types of carrying charges including storage, insurance, financing, and regulatory fees.  

Carrying charges and futures pricing 

A carrying charge which includes storage, insurance, and financing is the cost of holding an asset until a future date.  When carrying costs are high the futures price is often higher than the spot price, which is referred to as contango. When the futures price is lower than the spot price it's called backwardation. 

Carrying charge vs. inventory holding cost 

A carrying charge refers to the total costs of holding an asset until a futures date. Inventory holding costs on the other hand involve the expense of storing and maintaining inventory in supply chain management or operations. Inventory holding costs are part of inventory carrying costs which are applied to business operations rather than futures pricing.    

Why carrying charges matter for investors 

Carrying charges set future prices, shapes hedging costs, enables arbitrage opportunities, impacts ETF returns and signal market conditions. They enable retail investors and self-directed traders to get a better insight into pricing, risk and opportunity in commodities, futures, currencies and equity index derivatives.  

How do carrying charges affect futures prices? 

Carry charges are the key link between spot and futures prices. While carrying costs consist of storage, insurance, financing and other fees when determining future prices, it's important to also consider the convenience yield (benefit of physically holding the asset).  

 In general, the formula for futures pricing is:

F=S×e(r+c−y)T

Where:

F = Futures price

S = Spot price (today’s price)

r = Risk-free interest rate (financing cost)

c = Storage/other carrying costs (only for commodities)

y = Convenience yield (benefit of physically holding the asset, e.g., immediate availability)

T = Time to maturity (in years)

Contango 

A market condition where the futures price is higher than the spot price.

Backwardation 

When the carrying costs are low and the benefit of holding the physical asset outweighs the costs the future prices may trade below the spot price causing a phenomenon called backwardation.  It happens when the benefit from having a physical commodity in hand (convenience yield) is greater than the cost of storing and financing it (carry).

What is the difference between a carrying charge and storage fee? 

A carrying charge is the total cost of holding an asset until a future date. It is an important component to consider when it comes to the pricing of futures and arbitrage models. Carrying charges cover a wider scope and include all the costs associated with storage fees, insurance, transportation and taxes.   While a storage fee is a subset of carrying charges involving the cost of physically storing an asset.  

Why are carrying charges important in commodities trading? 

Carrying charges form a crucial part of commodities trading because they not only affect futures pricing but also hedging and arbitrage. The cost-of-carry framework links spot and futures prices by combining financing and storage-type costs and subtracting convenience yield, helping explain contango and backwardation. Carrying charges are also used for hedging by producers and consumers, while the producers carry charges affect the timing of a hedge, the consumers use futures to secure input costs. Traders also use carrying charges to take advantage of the differences between spot, carry and futures pricing. By doing so they can identify arbitrage opportunities with the goal of profiting from the mispricing.  

Does holding real estate come with carrying charges? 

Yes, holding real estate comes with carrying charges which are sometimes also called holding costs in the property markets. Owning property over time requires ongoing cash outflows in the form of mortgage payments if the property is purchased with debt, property taxes owed to the municipality, insurance, water, electricity, security and landscaping.  

What are inventory carrying costs? 

Inventory carrying costs entail the total expenses a business will incur to store and maintain used, sold or disposed inventory. In general, they fall into four distinct categories namely capital, storage, service and risk costs. Capital costs involve the opportunity cost of money tied up in inventory, including interest on loans. Storage consists of warehousing rent and utilities. Insurance, taxes and security fall under service costs and shrinkage, obsolescence and spoilage are all classified as risk costs. They are important because they reduce profitability and affect pricing and working capital.  In the context of futures or forwards, carrying costs represent the total cost of holding an asset until the delivery date, including financing costs (interest paid on borrowed funds). It’s a key component of the cost-of-carry model which links the spot price of an asset to its futures or forward price by factoring in the carrying costs.

What is the settlement rule for financial transactions? 

The settlement rule involves the process of transferring cash and securities between a buyer and seller to complete a trade. Once the settlement happens the trade is executed, and the transfer of ownership is finalized. The rule defines how long it takes for the transfer to be finalized, in general in the case of equities, corporate and municipal bonds (excluding U.S treasuries) it takes T+1(trade date + 1 business days).  

In the case of mutual funds, options and exchange traded funds (ETF) it takes T+1 (trade date + 1 business day) to settle the transaction. Spot FX transactions typically settle T+2, although some currency pairs use different conventions (for example, USD/CAD is commonly T+1).    Futures are settled daily using variation margin to account for the change in their market value in a mark-to-market process where profits or losses are credited to the margin accounts.  

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This material is for informational purposes only and should not be considered as an investment recommendation or a personal recommendation.