Cost of Carry Model
The cost of carry model is a mathematical framework used to determine the theoretical fair price of a derivative contract. It calculates the price by adding the costs associated with holding the underlying asset until the expiration of the contract, such as storage costs or financing interest, and subtracting any income earned from the asset, like staking rewards.
In traditional finance, this involves interest rates and physical storage; in crypto, it often involves staking yields and lending rates. If the actual market price deviates significantly from the cost of carry, arbitrageurs step in to restore balance.
This model is a cornerstone of derivative pricing, providing a benchmark for traders to assess whether a contract is overvalued or undervalued. It assumes efficient markets where price discovery is driven by rational participants minimizing their costs.
Understanding this model is critical for traders evaluating the profitability of holding long-term derivative positions.