DEFINITION of 'Carrying Charge'

Cost associated with storing a physical commodity or holding a financial instrument over a defined period of time. Carrying charges include insurance, storage costs, interest charges on borrowed funds, and other related costs. As carrying costs can erode the overall return on an investment, due consideration should be given to them in considering the suitability of the investment, and also while evaluating investment alternatives.

May also be referred to as cost of carry.

BREAKING DOWN 'Carrying Charge'

Carrying costs can be a deterrent for retail investors who wish to invest in physical commodities, since storage and insurance costs can be quite significant and a burden to navigate. Such investors may be better served by commodity exchange-traded funds, which have surged in popularity in recent years.

Carrying charges are generally incorporated into the price of a commodity futures or forward contract. Under normal market conditions, therefore, the price of a commodity for delivery in the future should equal its spot price plus the carrying charge. If this equation does not hold, due to abnormal market conditions or some other development, a potential arbitrage opportunity may exist.

For example, assume that the spot price for a commodity is $50 per unit, and the one-month carrying charge associated with it is $2, while the one-month futures price is $55. An arbitrageur could pocket a riskless profit of $3 per unit in this case by buying the commodity at the spot price (and storing it for a month for $2) while simultaneously selling it for delivery in a month at the one-month futures price of $55.

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