Cost of Carry Futures: Why Nifty Futures Trade Above Spot and How to Read the Premium

Pull up a Nifty futures quote next to the index and the futures number is usually a little higher. New traders often read that gap as the market “expecting” a rise. It isn’t. Most of that gap is plain arithmetic: the cost of carry in futures pricing, the money you would spend (or give up) to hold the underlying until expiry. Once you can put a number on it, the premium stops being noise and starts telling you something useful about whether a contract is cheap, rich or behaving oddly.

We’ll build the formula from scratch, run it on a Nifty-style example, show why the premium melts as expiry gets closer, and then look at three ways traders actually use it: judging a long futures position, reading a dividend-driven discount, and the cash-and-carry and calendar spreads that live off this gap. All the index levels, prices and rates in the worked examples are hypothetical. The formulas and definitions come from the sources linked in each section.

What cost of carry means in futures

Investopedia defines cost of carry as the expense of holding an investment, which includes financing, storage and insurance, and notes that in derivatives it has a big say in pricing. For a physical commodity the carrying costs are real bills: warehouse space, insurance, losses from things going stale. For a stock or an index there’s nothing to store, so the big item is financing. If you bought the shares today, your money would be tied up until expiry instead of earning interest somewhere safe.

That’s the whole intuition. A futures buyer gets the same exposure as a spot buyer without paying the full price upfront. So the futures price has to include roughly what the spot buyer loses by paying today, otherwise everyone would buy futures and park the rest of the cash in a bank. Equally, a spot holder who receives a dividend before expiry gets something the futures buyer doesn’t, and that comes off the futures price.

Commodity markets add another wrinkle. Investopedia’s version of the model is F = S × e^((r + s − c) × t), where r is the risk-free rate, s is storage cost as a share of the spot price, c is the convenience yield (the benefit of physically holding the commodity) and t is time to delivery as a fraction of a year. For equity futures in India, you can drop storage and convenience yield and use a simpler version.

The fair value formula traders use for Nifty and stock futures

Zerodha Varsity’s chapter on futures pricing writes it like this:

Futures price = Spot price × [1 + rf × (x/365)] − d

Here rf is the annual risk-free rate, x is the number of days to expiry and d is the dividend expected before expiry. Varsity suggests using the RBI’s 91-day Treasury bill rate, published on the RBI’s website, as a proxy for the short-term risk-free rate. The number this formula spits out is called the theoretical fair value. The price the contract actually trades at is the market price. The difference between futures and spot is called the basis or spread.

Varsity also makes two points that matter for everything below. First, fair value and market price are usually close but rarely identical, and the gap comes mainly from real-world costs such as transaction charges, taxes and margins. Second, the further away expiry is, the wider that fair-value-to-market gap tends to get. Near-month contracts usually hug fair value more tightly than far-month ones.

Worked example: pricing a hypothetical Nifty contract

Say the Nifty is at 25,000, there are 30 days to expiry, no meaningful dividend is due in that window, and we use 6% a year as the risk-free rate. (That 6% is an assumption for the example. When you do this for real, take the current 91-day T-bill rate from the RBI.)

• Carry for 30 days = 25,000 × 6% × 30/365 = 123.29 points
• Fair value = 25,000 + 123.29 = 25,123.29

So a premium of roughly 120-odd points over spot is not the market being bullish. It’s just the interest on 25,000 for a month. Only when the actual futures price moves well away from 25,123 is the market telling you something extra.

You can also flip the formula around. Take the market’s premium, divide by spot, and annualise it: implied carry = (futures − spot) ÷ spot × 365 ÷ days to expiry. That gives you a rate you can compare with the T-bill rate directly.

Each implied figure is simply premium ÷ 25,000 × 365 ÷ 30. For the first row, 150 ÷ 25,000 = 0.6% for the month, and 0.6% × 365/30 = 7.30% a year.

A futures premium is mostly interest, not optimism. The useful signal is how far the market price drifts from the interest you’d expect.

Premium, discount, contango and backwardation

When futures trade above spot, the contract is at a premium. Varsity calls this “the natural order of things”, since the formula itself pushes futures above spot whenever rates are positive and dividends are small. Commodity traders call the same situation contango. When futures trade below spot, the contract is at a discount, which the commodity world calls backwardation.

A discount isn’t automatically a bearish signal. Varsity lists short-term demand and supply imbalances, dividends, funding costs and positioning as the usual reasons. That’s why, before reading anything into a discount, the first thing to check is whether a dividend record date falls before expiry.

Worked example: the dividend discount

Take a hypothetical stock at ₹1,000 with 30 days to expiry, the same 6% rate, and a ₹15 dividend expected before expiry.

• Without the dividend, fair value = 1,000 × (1 + 6% × 30/365) = ₹1,004.93
• With the dividend, fair value = 1,004.93 − 15 = ₹989.93

The futures should trade about ₹10 below spot, and that’s entirely the dividend. A trader who reads that discount as “smart money is short” has misread a corporate action. The dividend goes to whoever holds the shares; the futures buyer doesn’t get it, so the futures price knocks it off up front.

Why the premium shrinks every day

The x in the formula is days to expiry, and it only goes one way. As it falls, the carry falls with it. On expiry day, futures and spot converge. Varsity puts it bluntly: whether the contract was at a premium or a discount, on expiry day they meet.

Here’s what that does to our hypothetical Nifty contract if the index sits still at 25,000 for the whole month:

This matters a lot for anyone holding long futures. Suppose you bought the contract at 25,150 with 30 days to go and the index ends the month exactly where it started, at 25,000. The market went nowhere, yet your position lost 150 points per unit because the premium you paid evaporated. On a hypothetical lot of 50 units, that’s ₹7,500 gone in a flat month, before brokerage and taxes. Short futures holders get the mirror image: they earn that premium as it melts, as long as the index doesn’t run up against them.

And if you don’t close the position before expiry, the exchange settles it under its final settlement process, which is linked to the underlying spot price. For stock futures, that can mean delivery of shares, which we explain in our piece on physical settlement in stock F&O.

How traders use cost of carry futures pricing in practice

1. Checking whether a long futures trade is worth the carry

If your view is that a stock will rise over the next month, futures and cash are both ways to express it. The futures route uses less capital, but you’re paying the carry baked into the price. A quick check: work out the implied carry, compare it with what your spare margin money could earn, and ask whether the expected move comfortably beats the premium. A ₹15 expected move on a contract carrying a ₹12 premium leaves you very little room. Leverage cuts both ways too, which is why position size matters more here than in cash. Our risk management in trading guide covers how to size a leveraged position.

2. Cash-and-carry arbitrage

When futures trade well above fair value, the textbook trade is to buy the cheaper leg (spot) and sell the expensive one (futures). Varsity calls this the cash-and-carry arbitrage. Because the two prices converge at expiry, the spread you lock in at entry stays locked in, wherever the market ends up, subject to execution costs and charges. Varsity also suggests closing both legs just before expiry rather than riding it to the end.

A hypothetical version: a stock trades at ₹1,000 in cash, with 30 days to expiry and no dividend due. Fair value at 6% is about ₹1,004.93, but the futures trade at ₹1,012. You buy in cash at ₹1,000 and sell futures at ₹1,012, locking in a ₹12 spread.

• If both settle at ₹960: cash leg −40, futures leg +52, net +12
• If both settle at ₹1,050: cash leg +50, futures leg −38, net +12

That ₹12 on ₹1,000 is 1.2% in a month, or about 14.6% annualised before costs, against a fair carry of under ₹5. In real markets, brokerage, transaction charges, taxes and the margin and capital you have to block in both legs eat into the spread, so the visible gap has to be comfortably wider than your total costs before the trade makes sense.

The reverse trade, when futures trade at a deep discount, means selling the stock in cash and buying futures. Shorting in the cash market comes with its own rules, which we explain in our guide to short selling in India.

Cash-and-carry doesn’t care where the market goes. It only cares that the two prices meet at expiry and that your costs are smaller than the gap.

3. Calendar spreads and the rollover cost

Varsity describes the calendar spread as an extension of cash-and-carry. Instead of trading spot against futures, you trade two futures contracts on the same underlying with different expiries: buy the cheaper one relative to its fair value and sell the richer one.

The same arithmetic tells you what rolling a position costs. Back to our hypothetical Nifty at 25,000 with a 6% rate:

• Near-month fair value (30 days) = 25,123.29
• Next-month fair value (58 days) = 25,000 × (1 + 6% × 58/365) = 25,238.36
• Fair spread between them = 115.07 points

Now suppose the market has the near month at 25,150 and the next month at 25,240. A long who rolls (sells near, buys next) pays a 90-point spread. Annualised over the 28 days between the two expiries, that’s 90 ÷ 25,150 × 365 ÷ 28, or about 4.66%, cheaper than the 6% assumption. A roll spread below fair carry favours longs who are rolling; a spread above it favours shorts. For the mechanics of the roll itself and how to read rollover data, see our explainer on Nifty futures rollover.

Mistakes we see traders make with the premium

• Reading every premium as bullish. A premium close to fair value is interest, nothing more. Compare it with the implied carry before you read sentiment into it.
• Ignoring dividends. A stock future at a discount just before a record date is usually pricing the payout. Check the corporate action calendar first.
• Comparing points across days to expiry. A 60-point premium with 15 days left and a 120-point premium with 30 days left are roughly the same carry. Always annualise.
• Forgetting costs in arbitrage maths. A spread that looks wide on screen can disappear once you add brokerage, transaction charges, taxes and the cost of blocking capital in two legs.
• Holding long futures in a flat market without noticing the melt. If your stop and target are set on the futures price, remember part of that price is guaranteed to drain away by expiry.

Quick routine before you trade a futures contract

1. Note spot, the futures price and days to expiry.
2. Check for any dividend record date before expiry.
3. Look up the current 91-day T-bill rate on the RBI website.
4. Work out fair value with the formula and the implied carry from the market price.
5. Decide whether the gap between the two is big enough to mean something, or just costs and noise.

Do this a handful of times and you’ll start to see the futures premium the way experienced F&O traders do: as a price for time, which is sometimes fair, sometimes too rich and occasionally on sale.

Disclaimer: This article is for information and education only and is not investment advice. All index levels, stock prices, interest rates, dividends and lot sizes in the worked examples are hypothetical and used only to illustrate the method. Futures are leveraged products and losses can be large. Do your own research and consult a SEBI-registered investment adviser before making any investment decision.