Sorry MG, I may not have explained myself very well. I understand the concept of cost of carry and how it relates to certain commodities. What I meant to ask is for the cost of carry input into an options pricing model, is using a rough estimate (based on some historical numbers or the difference between spot and futures , or the front two futures contracts or something similar) a close enough estimate or is this something that really needs to be kept up to date with as accurate, up to date information as possible from reliable sources?
Cost-of-carry in the options-pricing world generally refers to the risk-free-rate, and dividend yield; inputs into the forward multiplier (e^rt). Depending on the futures contract you intend to model, there may be other financing costs to consider. It's probably not too difficult to find these specs on the internet, or financial literature.
Thanks doobs, probably should have given a specific example but crude, gold and the major equity indexes are what I am currently looking at.
ManinJapan - remember the difference in theory v reality. The cost of carry for you will be different for others and yet the prices quoted and traded might simply be the cost of carry of the average market participant. If its your actual costs that you are interested then plug those in and see if its worth while on the actual prices you can trade at. Its probably amazing how many folks trade off theoretical prices but dont reconcile with their own actual trading costs.
Thanks all for trying to explain this for me, I'm still not sure I am much closer to finding a n actual number to use for calculating my Greeks exposure on my Crude Options Positions. ( I use optionvue and IB, but trying to build my own excel) I can understand that my costs will differ from others, but as per the explanation in Wikipedia : So I still need to estimate these costs (insurance, storage etc) before taking into consideration my own costs right? Or are these costs irrelevant to me if I am not trading the actual physical product, just the futures? In which case I just need to focus on my own opportunity cost and any financing costs Sorry, If the answers have more than enough information to solve the problem but while the theoretical concept of cost of carry is easy enough to follow, I am having a really hard time trying to get my head around a practical application of this....
Crude doesn't pay divs, so you don't need to really worry too much about the more granular aspects of the cost-of-carry and, consequently, about the "American-ness" of these options. Just use a halfway sensible rate and you'll be fine... The point made earlier about the calculations is that you have to be very clear about what you're trying to achieve in your computations. If you're looking to recover the "fair" market price of these options, you should use the inputs that a marginal mkt participant uses. That includes using the right interest rate (for the moment, it's not particularly relevant). As far as I know, the consensus rates currently used for pricing pretty much all derivatives are based on the FedFunds OIS curve (you can use CBOT FF futures to get an idea of rates). If, on the other hand, you're trying to get an idea of what the economic value of the option is to you, personally, you should use the inputs that apply in your particular circumstances. For instance, imagine if you had to use a credit card to post margin. In that case, your "effective" interest rate is VERY different to the marginal mkt participant. That could mean that the "fair" price of this option to you is very different to the mkt price.