What is 'Cash and Carry Transaction'

A cash and carry transaction is a type of transaction in the futures market in which the price of a commodity is below the futures contract price. Cash and carry transactions are considered arbitrage, and take place either with cash or on the spot market. It is sometimes also known as basis trading.

BREAKING DOWN 'Cash and Carry Transaction'

Cash and carry transactions take advantage of different price points between similar stocks, commodities and assets across varying markets and forms. This is typically due to inefficiencies in the market, as opposed to pricing errors, and most times these differences in prices are caught and fixed quickly. These transactions can take place in any market where there is a physical delivery mechanism.

Although the trading is thought to be practically risk free, there are some instances where it would not be as profitable. There are some factors to consider when deciding if a cash and carry transaction is worth the return, like fees, costs, and dividends that may need to be paid out on the stock. Prior to making cash and carry trades a thorough review of associated fees should be conducted.

Example of a 'Cash and Carry Transaction'

An example of a cash and carry transaction would be when LAH stock is trading at $40 a share on the stock exchange, but is set at $50 a share on the futures exchange. In order to close a cash and carry transaction, a trader would need to buy the stock at $40 a share on the spot, and then short the futures price at $50 a share. Then the trader would need to hold onto their share of LAH until such time as it is due and deliverable into the short futures contract.

The difference between the futures price and the spot price is $10, which allows for a $10 profit on the cash and carry, or a 10-percent return, not including costs or fees.

Consider another example where the share of LAH is trading at $80 per share, but is going for $100 per share on the futures market. Now, the profit margin has increased and after the short of the futures at $100 there is a $20 profit, or 20-percent return on the initial investment. It is easy to see how manipulating the arbitrage transactions can return a large profit with seemingly little risk. A lot of money can be made this way, but it is increasingly harder to take advantage of these inefficiencies as they are often caught quite quickly and remediated.

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