Full Carry

What Is Full Carry?

Full carry is a term that applies to the futures market and implies that the costs of storing, insuring, and paying interest on a given quantity of a commodity have been fully accounted for in later months of the contract compared to the current month.

Understanding Full Carry

Full carry is also known as a "full carry market" or a "full carrying charge market," and traders use these phrases to explain a situation where the price of the later delivery month contract equals the price of the near delivery month plus the full cost of carrying the underlying commodity between the months.

The full carrying costs include interest, insurance, and storage. This allows traders to calculate opportunity costs as money tied up in the commodity cannot earn interest or capital gains elsewhere.

It is reasonable to expect futures markets to have contracts for longer delivery priced higher than contracts for closer delivery because it costs money to finance and/or store the underlying commodity for that additional length of time. The term that describes higher prices for later contracts is contango. The natural occurrence of contango is expected for those commodities that have higher costs associated with storage and interest. However, anticipated demand in later months can put a premium on later contract prices fully independent of any carry costs.

For example, let's say commodity X has a May futures price of $10/unit. If the cost of carry for commodity X is $0.50/month and the June contract trades at $10.50/unit, this price indicates a full carry, or in other words, the contract represents the full cost associated with holding the commodity for an additional month. But if prices in later contracts rose above $10.50, this would imply that the market participants anticipate higher valuations for the commodity in later months for reasons other than the carry cost.

Carrying costs may change over time. While storage costs in a warehouse may increase, interest rates to finance the underlying may increase or decrease. In other words, investors must monitor these costs over time to be sure their holdings are priced properly.

Potential Arbitrage

Full carry is an idealized concept because what the market prices a longer futures contract is not necessarily the exact value of the spot price plus the cost of carry. It is the same as the difference between a stock's traded price and its valuation using the net present value of the underlying company's future cash flows. Supply and demand for a stock or futures contract change constantly so prices fluctuate around the idealized value.

In the futures market, longer delivery contracts could trade below near delivery contracts in a condition called backwardation. Some of the potential reasons may be short-term shortages, geopolitical events, and pending weather events.

But even if longer months trade higher than shorter months, they may not represent the exact full carry. This sets up trading opportunities to exploit the differences. The strategy of buying one contract month and selling the other is called a calendar spread. Which contract is bought and which is sold depends on whether the arbitrageur believes the market priced an overvaluation or undervaluation.