May

12

A carry trade is borrowing/buying at low interest and selling/lending at higher interest rates using leverage. Its used in currencies. The authors propose the trade had become systemic including the FED such that the markets have disconnected from fundamentals and are moved by dynamics of the carry/bust pattern. Further that it is the main driver of economic cycles not classic economic supply and demand.

If so, maybe the Fed watch traders are not always wrong as I've stated and the bad news is good news idea has merit under the carry trade.

Humbert H. writes:

Is there anyone who has done this for decades and not blown up, other than maybe Palindrome? Leverage combined with simultaneous forex and interest rate bets seems like it will eventually blow up, unless you always get advance warnings from central bankers.

Jeff Watson expands:

In the grain markets we determine the cost of carry as Futures price = Spot price + carry or carry = Futures price – spot price. Carry consists of storage costs, insurance, and interest. Carry provides the farmer with signals helping with crop marketing decisions while it provides a trader an opportunity to capture the carry. As an aside, here’s a handy dandy little formula to play around with:

F = Se ^ ((r + s - c) x t)
Where:
F = the future price of the commodity
S = the spot price of the commodity
e = the base of natural logs, approximated as 2.718
r = the risk-free interest rate
s = the storage cost, expressed as a percentage of the spot price
c = the convenience yield
t = time to delivery of the contract, expressed as a fraction of one year

Steve Ellison adds:

The US stock market had a carry trade from 2008 to 2018 and again in 2020 and 2021 when zero interest rate policy made it possible for traders to buy stocks with borrowed money, and cover the interest costs using the stock dividends. Philip L. Carret wrote in his 1931 book The Art of Speculation that the best time to buy stocks is in such situations when stocks "carry themselves".

As a quick approximation, the prices of the front-most ES contracts are:

June 5225
September 5282

So the cost of carry at the moment is roughly 47 points per quarter, and the S&P 500 is not carrying itself (if it were, the contracts would be in backwardation).


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