#1 Carry is what you are paid (or pay) to be in a trade
Carry looks different for different asset classes. Click on the links below to learn more.
Currencies
Carry = foreign risk-free rate − domestic risk-free rate
Example: EUR/USD (CME:6E)
Suppose euro deposits earn 2% a year and U.S. dollar funding costs 4%. A U.S. investor borrows dollars to save euros. If EUR/USD (the spot price) doesn’t change, the long position has approximately −2% annual carry (you pay to be in this trade). This trade can be implemented by buying 6E futures on the CME.
Rates
Carry = forward rate − risk-free rate
Example: US 10Y Treasury (CBOT:ZN)
Suppose today’s Treasury curve implies a 5% return over the next year on a US 10Y position if the curve stays unchanged. This includes bond income and the bond rolling down the curve as it ages (roll yield). In this example, 5% is the 10Y forward rate. Funding the position costs 4%, leaving about 1% annual carry (you are paid to be in this trade). This trade can be implemented by buying ZN futures on the CBOT.
Credit
Carry = credit spread
Example: US Duration-Hedged High Yield (CME:DHY)
Suppose high-yield bonds yield 8% while matched Treasuries yield 4%. After accounting for funding and the Treasury hedge, that leaves about 4% annual carry, if the curves stay unchanged and there are no defaults. The hedge leaves exposure to defaults and changes in credit spreads. This trade can be implemented by buying DHY futures on the CME.
Equities
Carry = dividend yield − risk-free rate
Example: S&P 500 (CME:ES)
Suppose the S&P 500’s dividend yield is 1% a year and funding costs 3.5%. Owning the index earns the dividends, but financing it costs more. A long position has −2.5% annual carry: you pay to be in the index. This trade can be implemented by buying ES futures on the CME.
Commodities
Carry = convenience yield − storage costs − risk-free rate
Example: West Texas Intermediate (NYMEX:CL)
The convenience yield is the benefit of having the commodity on hand, while the storage cost is...the cost of storing it. Neither convenience yield nor storage costs are directly observable. Instead, they are inferred from the shape of the futures curve. Suppose WTI oil spot is $75 a barrel and a CL contract expiring in one year trades at $72. If spot stays at $75, the contract gains $3 a barrel as it expires. That is about 4.2% annual carry on the $72 futures price. This trade can be implemented by buying CL futures on the NYMEX.
#2 Carry is about growth and risk
Carry can be high because investors demand more compensation for risk, because they expect the price to fall, or both. Click on the links below to learn more.
Currencies
Why is the foreign rate higher than the domestic rate?
Rates
Why is the yield curve steep?
Credit
Why are credit spreads tight?
Equities
Why are dividend yields high?
Commodities
Why is WTI backwardated (futures below spot)?