Hedging with Jorge #Episode21: Understanding borrowing in carry trades

Carry trades are a key strategy in commodity trading, and today, we’re diving into the concept of borrowing. Let’s break it down with an example.

Imagine you’re a speculator, and you’ve taken a short position for April. Now, you realize you need to move this position to June. Can you just call your broker and ask them to “shift” your April short to June? Unfortunately, it doesn’t work like that.

Here’s what happens:

1. Closing the April Position: To move your position forward, you must close the current contract by doing the opposite action. Since you’re short in April, you’ll need to buy April to close it.
2. Opening the June Position: Simultaneously, you’ll sell June to open a new short position for that month.

This combined action of buying the nearer month (April) and selling the later month (June) is known as borrowing. It’s a key part of managing positions in the futures market.

Why is it called borrowing?

Borrowing in this context means shifting your position forward in time. You “borrow” from the future by selling a later contract while closing the current one.

What’s next?

Borrowing is just one type of carry trade. The other, lending, involves the reverse process. We’ll explore lending in detail next time, along with how the curve behaves when the market is in contango.

Stay tuned for more insights on carry trades and the nuances of trading strategies!