Cost of Carry or CoC is the cost to be incurred by the investor for holding certain positions in the underlying market till the futures contract expires. The risk-free interest rate is included in this cost. Dividend payouts from the underlying are excluded from the CoC.
CoC is the difference between the futures and spot price of a stock or index. The Cost of Carry is important because higher the value of CoC, higher is the willingness of the traders to pay more money for holding futures.
Theoretically, Future price fair value=Spot Price+Cost of Carry-Dividend Payout Cost of Carry = Difference between the futures and spot price at any time
CoC is calculated as an annual rate and expressed in percentage values. The real-time CoC values are available on stock exchange websites.
The value of CoC is used as an indicator to understand the market sentiment i.e. Low CoC means there is a fall in the value of the underlying and vice versa.
Traders often refer to CoC to gauge market sentiment. Analysts interpret a significant fall in CoC as an indicator of an impending fall in the underlying. For example, CoC of benchmark index Nifty futures dropped by nearly half a fortnight ago, and served as an indicator of the consequent correction in the index. Conversely, when the CoC for a stock future rises, it means that traders are willing to incur higher costs for holding the position and, thus expect a rise in the underlying. CoC is expressed as an annualised figure in percentage.
Yes. When futures trade at a discount to the underlying, the resultant cost of carry is negative. This usually happens for two reasons: when the stock is expected to pay a dividend,or when traders are aggressively executing a “reverse arbitrage” strategy, which involves buying spot and selling futures. Negative cost of carry points to bearish sentiment.
Change in CoC seen along with open interest shape a clear picture of broader sentiment for the stock or index. Open interest is the total number of open positions in a contract. For a rising OI, an increase in CoC indicates accumulation of long (or bullish) positions, while an accompanied fall in the CoC indicates addition of short positions and bearishness. Likewise, a fall in OI accompanied with a rise in CoC, indicates closure of short positions. Falling OI and CoC indicate that traders are closing long positions. Analysts also observe changes in CoC at the expiry of the derivatives contract. If a significant number of positions are rolled over with a higher cost of carry, it implies bullishness.