Start Trading Now
Sign up for ZitaPlus, where knowledge and personalized support come together for your success.
Open Real Account Open Demo Account
Carry trades are often associated with currency markets, but the same principles can apply to commodities. Carry trades are used in investing in something that has a higher return with borrowing money at a lower cost, with the goal of making money off the difference. In commodities, carry trades use the price differences between current (spot) prices and future prices while managing costs like storage and financing.
For traders and investors planning on long-term gains, commodity carry trades can add structure and potential yield to a portfolio. Like any strategy, they require a clear understanding of market conditions, costs, and risks.
In this article, we will explore what carry trades mean in the context of commodities, how they work, and the steps involved in setting up a carry trade. We will also look at examples, benefits, and potential risks to help you see how carry trades can become a useful part of your trading or investment strategy.
A carry trade is a strategy where an investor borrows funds at a lower interest rate to invest in an asset that offers a higher return. The goal is to earn the difference between the borrowing cost and the return on the investment.
Carry trades are often considered in currencies, where traders borrow in a currency with low interest rates and invest in one with higher rates. However, this concept can also apply to commodities, though it looks different in practice.
In commodities, the carry trade involves using the price difference between the spot price and the futures price, taking into account costs like storage, insurance, and financing. Traders look for situations where the futures price is higher than the spot price by more than the combined holding costs. The potential profit comes from earning this “carry” while holding the commodity or its equivalent exposure through futures.
This strategy can benefit traders and investors looking for steady returns, especially in markets where the futures curve supports a carry trade. A carry trader needs to be familiar with concepts like contango and backwardation, which shape the futures pricing environment.
Carry trades in commodities rely on the relationship between the spot price and futures prices while considering the costs of holding the commodity over time.
Carry trades in commodities typically work in contango markets. Here, traders buy the physical commodity or a near-term futures contract while selling a longer-term futures contract to capture the price difference.
To profit from a commodity carry trade, the futures premium over the spot price needs to be larger than the combined costs of storage, insurance, and financing. If these conditions are met and the futures curve remains stable, the trader can earn the “carry” when the futures contract expires or is rolled over at a profit.
Carry trades in commodities require careful monitoring of:
Carrying out a commodity carry trade involves preparation and ongoing management. Here are the practical steps to follow:
Look for commodities trading in contango, where futures prices are higher than the spot price by a margin that could cover costs and leave a profit. Use futures curves available on trading platforms or data services to find potential trades.
Include all costs associated with holding the commodity:
These costs will determine if the futures premium is sufficient for a profitable carry trade.
If you're borrowing funds to execute the trade, make sure you understand the interest rate you will pay and how it compares to the potential return from the carry trade.
Decide whether you will:
For many traders, futures contracts are practical as they avoid the challenges of physical delivery and storage.
Keep track of:
If the carry trade continues to be profitable, have a clear exit strategy in place, either by contract expiration or by rolling to a new futures contract.
Knowing how carry trades in commodities function and how traders use them for possible returns can be made easier by looking at actual examples.
Oil often trades in contango, especially when supply is high or demand is low. Traders may buy physical oil or near-term futures and sell longer-dated futures to lock in the price difference. If storage costs and financing are lower than the futures premium, the trader can earn a return when the futures contract settles or is rolled over. Also, buying and storing oil physically is quite difficult for regular traders or investors.
Gold can also be used in carry strategies, especially when lease rates are low. Traders may borrow gold at a low lease rate, sell it in the spot market, and invest the proceeds in interest-bearing instruments. The goal is to earn the interest spread while planning to repurchase gold later, ideally at a lower price if conditions allow.
Carry trades in grains or soft commodities may occur around harvest seasons, when supply is high, and futures trade in contango. Traders can buy and store the commodity, selling futures to capture the premium while managing storage and financing costs.
Many traders prefer futures spread strategies instead of physical storage. They may go long on a near-term futures contract while shorting a longer-term contract, aiming to profit from the narrowing spread as contracts approach expiry.
Carry trades in commodities can add structure and yield potential to a trading or investment strategy. However, they come with risks that require careful management.
| Benefits | Risks |
| Potential for steady, structured returns | Market volatility may reduce premium |
| Adds portfolio diversification | Futures curve changes can impact profitability |
| Fits long-term trading strategies | Financing and storage costs may increase |
| Liquidity and roll risks in futures markets |
Managing these risks involves:
Carry trades are suitable for long-term strategies. It is a good option for traders and investors who prefer structured approaches to building returns. Here’s how they can fit into your overall plan:
Carry trades can provide steady return potential by capturing the futures premium in contango markets. If you combine them with other strategies, they can add a yield-focused element to your portfolio without relying on traditional interest-bearing assets.
Carry trades can be used alongside hedging to manage price risks. For example, an oil producer might use a carry trade to lock in future prices while holding physical oil. This way, they can reduce exposure to price declines while earning the futures premium.
Monitoring interest rates and supply-demand trends helps align carry trades with broader market conditions. For example, low-interest-rate environments can reduce financing costs. This increases the attractiveness of carry opportunities in commodities.
Long-term carry trade strategies require patience and discipline, focusing on gradual gains rather than chasing short-term volatility. Monitoring market conditions, managing costs, and adjusting positions when futures curves shift are key to maintaining a healthy carry trade approach.
Carry trades in commodities offer a structured way to participate in markets while aiming for steady returns. Traders and investors can earn potential yield even in non-interest-bearing assets like commodities by using the price differences between spot and futures markets.
While carry trades require attention to costs, market conditions, and futures curve structures, they can fit well into a long-term portfolio, adding diversification and stability. Carry trades are not risk-free, but they can help you earn while you hold.
Can individual traders use carry trades in commodities?
Yes, traders can use carry trades through futures contracts or ETFs without handling physical commodities.
What is contango, and why is it important for carry trades?
Contango is when futures prices are higher than the spot price, creating opportunities to earn carry if the premium exceeds costs.
Are commodity carry trades risk-free?
No, risks include price volatility, changes in the futures curve, and rising storage or financing costs.
Do carry trades work in all commodity markets?
They are more effective in markets with stable contango structures, like certain oil or grain markets, but not all commodities will offer suitable conditions.
How long should I hold a commodity carry trade?
It depends on the market and your strategy, but many carry trades align with medium to long-term approaches, held until futures expiry or roll opportunities.
Would like to learn how to look financial markets from a different angle? Then keep reading and invest yourself with ZitaPlus.
