The cash and carry trade is a type of arbitrage strategy that involves two trade components in order to complete the transaction. Essentially, a security will be purchased, and the asset underlying the security is sold at a short trade. In other instances, a cash and carry trade will involve the purchase of a security and the subsequent sale of a similar security.
Cash and carry trades are sometimes referred to as trading on the basis or basis trading. It is not unusual for the transaction to involve futures as the component that is sold after a similar security is purchased. The components involved in the strategy can be a stock, a commodity or an index as the security that is purchased, while a futures contract will often be the component utilized for the sale that completes the arbitrage approach.
One of the ideas behind the cash and carry trade is to deal with situations where the investor feels there is there is a discrepancy between the prices of the two securities involved. Essentially, the acquisition of one security and the subsequent sale of the other security is anticipated to balance out the discrepancy. By realizing a gain on one component that is sufficient to offset the loss on the other component, the investor manages to achieve a state that he or she feels is more equitable.
In order to obtain the desired result, the cash and carry strategy will work if the purchase price of the security, along with the addition of the associated cost of carry, will need to be less than the price on the futures contract. When this sort of situation exists, the cash and carry trade can result in a desirable return on the strategy. However, if the combination of the cost of carry and the price of the acquired security exceeds the price of the futures, then the strategy will fail. If there is not a desirable security available at a price that will allow for the successful implementation of a cash and carry trade, the investor would be well advised to consider other strategies in order to strengthen his or her position.
