What Are Carry Trades — Profit From Cash-and-Carry Arbitrage

What Is a Carry Trade?

A carry trade is a sophisticated form of arbitrage that capitalizes on price discrepancies between futures and spot prices in financial markets. This strategy involves taking a position in the spot market while simultaneously taking the opposite position in the futures market. The elegance of this approach lies in its market-neutral nature: since one leg of the trade gains value as the other loses value, the trader remains insulated from directional market movements.

The fundamental principle behind carry trade profitability is rooted in the pricing dynamics of futures contracts. These contracts are typically priced above or below the spot price, reflecting the market's collective perception of where the underlying asset's price will move by the settlement date. This divergence from the current spot price creates opportunities for traders to profit with relatively controlled risk exposure.

When the spot price trades below the futures price, the market is said to be in contango. In this scenario, a standard carry trade—buying spot and shorting futures—will typically yield profits as the prices converge. Conversely, when the futures price is below the spot price, the market is in backwardation, and a reverse carry trade (shorting spot and longing futures) becomes the more favorable strategy.

Successful carry traders actively seek the widest possible spread between spot and futures prices. As the settlement date approaches, this spread naturally narrows because the time window for price fluctuations diminishes. By settlement, the two prices will have converged to the same level. Traders can close both positions profitably whenever the spread becomes narrower than it was at entry, locking in the difference as profit.

An advanced technique involves "rolling over" the trade. When settling the futures leg of a carry trade, if a wide spread exists between the spot price and a longer-term futures contract, the trader can short the further-dated contract while maintaining the spot position. This creates a new carry trade with an extended settlement date, potentially maximizing profit opportunities.

Carry Trades With Perpetual Swaps

Beyond traditional futures contracts, cryptocurrency traders can implement carry trades using perpetual swaps. These instruments present unique characteristics that differentiate them from standard futures contracts. Since perpetual swaps lack a defined settlement date, the spread between the perpetual swap price and spot price may take longer to narrow. However, cryptocurrency markets are characterized by high volatility, and price reversals are common, which can lead to rapid changes in the spread or even complete reversals.

While this volatility can result in losses, diligent monitoring of carry trades between spot and perpetual swap markets enables traders to close both positions when the spread narrows, securing profits. The key is maintaining disciplined position management and having clear exit criteria.

Perpetual swap carry trades offer an additional profit mechanism through the funding rate mechanism. Since perpetual swaps have no settlement date, they employ this periodic payment system to prevent contract prices from drifting too far from the underlying asset's spot price. The funding rate represents a periodic payment made from one side of the trade to the other, essentially incentivizing participants on the losing side to maintain their positions.

When the perpetual swap price exceeds the underlying asset's spot price, the funding rate is positive. In this situation, traders holding long positions must make payments to those holding short positions. Conversely, when the perpetual swap price falls below the underlying spot price, the funding rate becomes negative, and short position holders pay long position holders.

For carry traders, this creates a unique advantage. When longing in the spot market and shorting a higher-priced perpetual swap, the trader receives positive funding rate payments simply by keeping the position open, as long as the perpetual swap price remains above the asset's market price. The opposite applies when the funding rate is negative. Remarkably, this means the spread doesn't necessarily need to narrow for the carry trade to generate profits—the funding rate payments alone can provide consistent returns.

The essential characteristics that define a carry trade include:

• Must consist of exactly two legs
• One position must be in the spot market and the other in futures or perpetual swap markets
• Positions must be opposite (one long, one short)
• The quantity of the traded asset must be identical across both legs
• The trader must buy in the spot market and short either a futures contract or perpetual swap (with the opposite being true for a reverse carry trade)

Crypto Carry Trade Example

To illustrate how a carry trade works in practice, let's examine a detailed example.

Consider a scenario where a trader buys 1 BTC for 25,000 USDT in the spot market. Simultaneously, they short a futures contract, effectively agreeing to sell 1 BTC for 25,200 USDT at a future settlement date. This creates a 200 USDT spread between the two positions.

Scenario 1: Bullish Market Movement

By the settlement date, BTC's price has risen to 30,000 USDT. The trader sells their 1 BTC in the spot market for 30,000 USDT, realizing a 5,000 USDT profit on the long leg. Meanwhile, their futures contract settles at exactly 30,000 USDT, meaning their short position has incurred a 4,800 USDT loss. The net result: 5,000 USDT profit minus 4,800 USDT loss equals 200 USDT net profit.

Scenario 2: Bearish Market Movement

By the settlement date, BTC's price has fallen to 15,000 USDT. The trader sells their 1 BTC in the spot market for 15,000 USDT, incurring a 10,000 USDT loss on the long leg. However, their futures contract also settles at 15,000 USDT, generating a 10,200 USDT profit on the short position. The net result: 10,200 USDT profit minus 10,000 USDT loss equals 200 USDT net profit.

Scenario 3: Neutral Market Movement

By the settlement date, BTC's price remains at 25,000 USDT. The trader sells their 1 BTC for 25,000 USDT (no profit or loss) and closes their short position at 25,200 USDT. With no profit or loss realized on the spot leg, the 200 USDT difference from the futures leg becomes the net profit.

These scenarios demonstrate the market-neutral nature of carry trades: regardless of price direction, the trader captures the initial spread as profit.

Why Trade Cash-and-Carry Arbitrage?

Cash-and-carry arbitrage represents a straightforward yet powerful approach to profiting from price discrepancies between crypto spot prices and their equivalent futures contracts. The strategy's primary appeal lies in its directional neutrality—traders need not make any predictions about whether the underlying asset will rise or fall in value.

When implementing carry trades between spot prices and futures contracts, the profit potential is essentially predetermined from the moment of entry. The spread between the two prices represents the maximum potential profit, which becomes realized as the prices converge toward settlement. This predictability makes carry trades particularly attractive for risk-averse traders seeking consistent returns.

However, perpetual swap carry trades operate somewhat differently. Since perpetual swaps lack a defined settlement date, their prices don't converge with spot prices in as predictable a manner as futures contracts. This introduces additional uncertainty but also creates opportunities for enhanced returns through funding rate payments.

Carry trades using either perpetual swaps or futures become particularly attractive in highly volatile markets. Extreme price movements often result in spreads narrowing favorably in perpetual swap carry trades or before settlement in futures carry trades. This volatility can accelerate the convergence process, allowing traders to close positions earlier than anticipated while still capturing substantial profits.

While spreads between futures and spot prices are often narrow relative to the position sizes required to generate meaningful profits, the volatile and sometimes inefficient cryptocurrency markets frequently present more attractive carry trade opportunities than those typically found in more established traditional markets. When perpetual swap funding rates are factored into the equation, the potential returns become even more compelling.

For high net worth individuals, institutional investors, and professional traders, crypto carry trades offer an attractive option even when market direction remains unclear. The strategy provides a way to generate returns while maintaining capital deployment in the market, without taking on significant directional risk.

Carry Trade Risks

While carry trades may appear to be a low-risk method for generating consistent returns, they come with several important considerations and potential drawbacks that traders must understand.

The primary concern is capital efficiency. Carry trades lock up trading capital for extended periods, potentially preventing traders from capitalizing on more profitable opportunities that may arise in dynamic markets. This opportunity cost can be significant, especially in fast-moving cryptocurrency markets where lucrative trading opportunities can emerge and disappear quickly.

A related challenge is the relatively narrow spreads between futures and spot prices compared to the position sizes required to generate meaningful returns. This necessitates deploying substantial capital to make the strategy worthwhile, further exacerbating the capital efficiency issue. For smaller traders, the capital requirements may be prohibitive, limiting the strategy's accessibility.

To address the capital efficiency problem, traders often employ leverage on the futures leg of the trade. However, leverage introduces its own set of risks. Should the market move adversely and trigger a liquidation of the futures position, the trader may lose money on a strategy specifically designed to eliminate directional risk. This counterintuitive outcome highlights the importance of careful risk management when using leverage in carry trades.

Carry trades involving perpetual swaps carry additional risks compared to those using futures contracts. With futures, the known settlement date ensures that contract prices will converge with spot prices. Perpetual swaps, lacking this defined endpoint, may take much longer for spreads to narrow sufficiently for profitable exit. In extreme cases, if the market transitions from contango to backwardation, traders may face extended periods before they can close positions profitably. This can result in either missing profitable opportunities elsewhere or being forced to close the carry trade at a loss.

Execution risk represents another critical consideration. While carry trades involve a long spot leg that can simply be sold if the futures leg doesn't fill, this still incurs trading fees. Given the substantial position sizes required to make carry trades worthwhile, these fees can accumulate to significant expenses with no corresponding gain if the trade doesn't execute as planned.

Fortunately, major exchanges offer various tools to help mitigate execution risk. Advanced block trading platforms enable traders to execute two or more trade legs simultaneously, completely eliminating the risk of only one leg filling and leaving the trader exposed to directional risk.

Getting Started With Cash-and-Carry Arbitrage

Leading cryptocurrency exchanges offer various tools and features to help traders execute sophisticated trading strategies like carry trades. While traders can manually implement a carry trade by buying crypto in the spot market and entering a short position in the futures market, this approach introduces execution risk. Even if both legs fill successfully, attempting to perform a cash-and-carry trade manually makes it less likely that the trader will achieve optimal pricing due to cryptocurrency markets' notorious volatility.

Block Trading

Advanced block trading platforms make implementing carry trades and various other multi-leg trading strategies significantly easier and more efficient. These platforms allow traders to execute both legs of a carry trade simultaneously, ensuring optimal pricing and eliminating execution risk.

When deploying a cash-and-carry trade through a block trading platform, traders typically follow these steps:

First, select the cryptocurrency asset you want to trade from the available options in the pre-defined strategies section. Choose the carry trade strategy template to begin building your position.

Next, enter the trade details for both legs. For the spot leg, specify the amount of the asset you want to purchase. For the futures leg, select whether you want to use crypto-margined or USDT-margined futures contracts. Then choose the settlement date from the available expiry dates and enter the required amount to match your spot position.

If you prefer to use a perpetual swap instead of a futures contract for the second leg, simply select the perpetual swap option and configure the trade parameters accordingly. Remember that perpetual swaps offer the additional benefit of funding rate payments but lack the predictable convergence timeline of futures contracts.

Before executing the trade, carefully review the details of both legs to ensure they align with your strategy. Verify that the position sizes are identical, the sides are opposite (long spot, short futures), and the pricing provides an acceptable spread for your profit targets.

Modern block trading platforms typically use a Request for Quote (RFQ) system, where you submit your trade specifications and receive competitive quotes from multiple counterparties. This ensures you receive optimal pricing for your carry trade.

Once you accept a quote, both legs execute simultaneously in full, eliminating the risk of partial fills or one-sided execution. The assets purchased in the spot market will appear in your trading account, while the open futures position will be visible in your positions dashboard.

To close the carry trade, you have two options. You can wait until the spread narrows to your target level or until the futures contract approaches settlement. Alternatively, if you're using perpetual swaps and the funding rate is favorable, you might choose to maintain the position longer to collect additional funding rate payments.

Closing the trade involves selling the assets in the spot market through either a market or limit order, and simultaneously closing the futures or perpetual swap position. Again, using block trading features ensures both legs close simultaneously, maintaining the market-neutral profile throughout the trade lifecycle.

FAQ

What is Cash-and-Carry Arbitrage? What is the basic principle?

Cash-and-Carry Arbitrage exploits price differences between spot and futures markets. Traders buy assets at lower spot prices while simultaneously selling futures contracts at higher prices, locking in risk-free profits from the spread when contracts expire.

How to execute spot-futures arbitrage trades? What are the specific steps and operational procedures?

Buy cryptocurrencies in spot market at lower price, simultaneously sell futures contracts at higher price. Monitor basis spread continuously. Close both positions when spread narrows to target level. Execute simultaneously to minimize slippage and price risk during the arbitrage process.

What are the risks of spot-futures arbitrage and how to manage them?

Key risks include basis risk from price divergence, funding rate volatility, liquidation risk, and counterparty risk. Manage by monitoring basis spreads closely, setting stop-losses, maintaining adequate margin, diversifying positions, and using hedging strategies to lock in arbitrage opportunities.

What is the difference between cash-and-carry arbitrage and reverse cash-and-carry arbitrage?

Cash-and-carry exploits spot-futures price gaps by buying spot assets and shorting futures when futures trade higher. Reverse cash-and-carry does the opposite: shorting spot while going long futures when spot trades above futures. Both profit from convergence as expiration approaches.

What conditions are required to conduct spot-futures arbitrage in the actual market?

You need sufficient capital for margin requirements, access to both spot and futures markets, low transaction costs, real-time price monitoring, automated trading tools, and sufficient trading volume to execute positions quickly without significant slippage.

What is the typical profit margin for spot-futures arbitrage? What factors affect it?

Spot-futures arbitrage profits typically range from 0.5% to 5% annually, depending on basis spread, funding rates, and trading volume. Key factors include price differences between markets, transaction costs, capital efficiency, market volatility, and liquidity conditions.

What are the characteristics of spot-futures arbitrage for different commodities such as soybeans, oil, and metals?

Different commodities show distinct carry trade patterns. Soybeans and agricultural products have seasonal basis fluctuations driven by harvest cycles. Oil exhibits storage cost sensitivity and geopolitical premiums. Metals like gold show lower storage costs but higher financing rates. Each commodity's basis spread, liquidity, and storage characteristics determine arbitrage profitability and timing strategies.

How do trading costs (fees, financing costs, storage costs) affect arbitrage profits?

Trading costs directly reduce carry trade profits. Higher fees, financing charges, and storage expenses narrow your margin. Even small costs compound significantly—a 0.5% fee on each leg plus daily funding rates can eliminate potential gains. Efficient execution and competitive rates are essential to maximize net returns.