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The cost of carry is generally understood to be the cost that is associated with holding on to a physical commodity for a specified period of time. There are several different forms of expenses that can rightly be considered cost of carry, including storage, insurance on the physical commodity, and any funding costs incurred in acquiring and maintaining control of the commodity.
Storage costs are a prime example of a cost of carry. For as long as the investor owns the securities in question, there is a need to warehouse the physical commodities in an environment where they can be properly maintained. Often, this involves not only a monthly rental or leasing fee for the warehouse, but also costs associated with the labor required to adequately monitor the condition of the commodity.
Insurance premiums are another form of cost of carry. While in the control of the investor, it is often a good idea to insure the commodities. In the unlikely event that something unexpected happens to the commodities, such as a natural disaster, the investor can call upon the insurance coverage to at least partially recover from the loss. While insurance is not universally required by law to maintain physical commodities, it is generally considered an essential part of responsibly caring for the investment.
Funding costs as they related to cost of carry can begin during the acquisition process. In the event that the commodities were bought on margin, the investor may eventually be subject to interest payments on the amount borrowed to make the purchase. As long as there is an outstanding balance due, interest will accrue and the investor will be expected to make interest payments. Dividend payments that are made on short positions can also be reasonably considered a funding cost as well.
In general, investors attempt to manage the cost of carry by buying and selling the commodities within given time periods. This can help to minimize some of the expenses or costs associated with owning the commodities, while still allowing the investor to make a profit while in the possession of the investment.
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