Positive Carry

Positive carry is a strategy of holding two offsetting positions and profiting from a price difference. The first position generates an incoming cash flow that is greater than the obligations of the second.

Similar to arbitrage, positive carries often occur in the currency markets, where interest that investors receive in one currency is more than they have to pay to borrow in another currency.

A more specific example of a positive carry would be borrowing $1000 from the bank at 5% and investing it into a bond paying 6%. Thus, the coupon on the bond would pay more than the interest owing on the loan to the bank, and you pocket the 1% difference.

While positive carry can result from differences in valuation, based on the underlying stability or instability of a security’s cash flows, arbitrage exists as a result of market inefficiencies. For example, Company A might trade at $30 on the New York Stock Exchange (NYSE) but $29.95 but on the London Stock Exchange (LSE) simultaneously. A trader can purchase the stock on the LSE and immediately sell the same shares on the NYSE, earning a profit of 5 cents per share.

Advanced technologies such as high frequency and computerized trading has made it for more challenging to profit from such pricing errors in the market. Any fluctuations in similar financial instruments will be quickly caught and corrected.

Trades involving positive carry are heavily reliant on the policies of the Federal Open Market Committee (or FOMC). The federal open market committee is the branch of the U.S. Federal Reserve Board that determines the nation’s monetary policy, including buying or selling U.S. government securities on the open market. These decisions affect interest rates on securities worldwide.

For example, to tighten the money supply in the United States and decrease the amount available in the banking system, the Fed will decide to sell government securities. Any securities the FOMC purchases will be held in the Fed's System Open Market Account (SOMA). The Federal Reserve Act of 1913 and Monetary Control Act of 1980 granted the FOMC permission to hold these securities until maturity or sell them when they see fit. The Federal Reserve Bank of New York executes all of the Fed's open market transactions.

Wall Street scrutinizes the 8 (secret) annual meetings of the FOMC to figure out if the committee is about to embark on several tightenings, will remain on hold and not change interest rates, or raise rates to slow inflation.