Consider a situation where a high-net-worth investor, having exhausted their portfolio allocation in equity mutual funds, asks you about hedging their concentrated exposure using index futures. They are convinced that futures are essentially ‘interest-bearing instruments’ because they have heard that the futures price is just the spot price plus financing costs. As a distributor, your role is to pivot them from this simplistic mathematical view to a broader understanding of market reality.
The Cost of Carry model rests on the assumption that you can freely borrow funds, short-sell assets without restriction, and that no significant market frictions exist. In the Indian market context, however, these assumptions often collide with reality, such as when securities are under a ban period in the F&O segment or when liquidity dries up during periods of high volatility.
When assessing whether a client should use derivatives for hedging, you must explain that these pricing models are not guarantees. They are merely theoretical benchmarks. If your client treats the theoretical ‘fair value’ of a future as a fixed profit opportunity, they ignore transaction costs like brokerage, Securities Transaction Tax (STT), and the potential for margin calls that can erode capital.
For an investor entering a Specialized Investment Fund strategy that utilizes derivatives, it is vital to disclose that these products carry leverage risk that traditional equity mutual fund schemes do not. The model assumes perfect market efficiency, but in practice, market participants often price in future expectations—such as upcoming corporate earnings or geopolitical events—which can cause the futures price to diverge significantly from the calculated cost of carry.
This distinction becomes critical when you are performing a suitability assessment for an HNI client who meets the ₹10 lakh minimum investment threshold for a SIF. If a client mistakenly believes that derivative-based strategies are ’low risk’ because they follow a mathematical model, you are failing in your duty to highlight the underlying market risk. By clarifying that these models assume perfect, costless access to markets—which is rarely the case for individual investors—you protect your client from unrealistic expectations.
Always remember that for the distributor, the goal is not to prove that you can calculate the price of a future, but to ensure the client understands the risks of the vehicle they are choosing.
Ultimately, a robust advisory practice is built on distinguishing between theoretical market models and the practical reality of execution. Never let a client treat a derivative product as a risk-free arbitrage play, as this exposes both you and your client to unnecessary financial and regulatory risk.
Nuance
Check Your Understanding
Which of the following is a fundamental assumption of the Cost of Carry model that is frequently violated in the actual Indian equity derivatives market?
If an investor observes that the futures price of a stock is lower than its spot price even after adjusting for dividends, and there are no barriers to short-selling, what does the Cost of Carry model imply?
This is a companion read for Section 15.7 — Futures pricing from Pass Certification Examination for Mutual Fund - Specialized Investment Fund Distributors by Akhilesh Gururani, available on Amazon Kindle.
Copyright © 2026 Akhilesh Gururani. All rights reserved.