Cash future arbitrage is basically an opportunity to earn risk-free profit from an unusual difference between cash and future prices in the stock market. There is normally an appreciable and exploitable difference between the Cash price and future price, especially at the beginning of the month. This difference is known as basis (basis = cash price - future price). Smart investors having investible sum in the range of 3 to 5 lakhs can earn risk free profit using cash future arbitrage. In a cash-futures arbitrage, a trader sells the futures that are quoting at a premium (or buys the future that is quoting at a discount) to the stock, and buys (or sells) an equivalent quantity of the underlying shares, the difference between the two being his profit. Closer to the derivative expiry when both future and spot prices almost coincide, the trader squares of his positions in both segments - buying futures and selling shares or selling future and buying shares. This strategy yields the best returns when the futures are quoting at a significant premium or discount to the spot price. To help investors benefit from cash and future arbitrage, Equityfriend prepares the list of all the arbitrage opportunity available on NSE every evening. Investors can use the list below to take arbitrage positions on the next trading day.
There are basically two types of cash and future arbitrage strategy:
Day Strategy – In this strategy, the arbitrager tends to square up on the same day when the difference between cash and future price shrinks. For example, say the Reliance share cash price is Rs 950 and the futures price is Rs 960. Since the markets are at times very choppy, the cost of carry between the futures and spot varies. Supposing one initiates a trade at a cost of carry of Rs 10. Whenever the difference shrinks to Rs 5 to 6 in the same day, the arbitrager reverses the position.
Monthly Strategy – In this strategy, the arbitrager enters the arbitrage position at the beginning of the month and holds it till the expiry day. On the expiry day, when the cash and future prices converge, he closes both the positions pocketing the price difference at the beginning of the month as the profit. For example, say the Reliance spot price is Rs 950 and futures is at Rs 960, with 28 days to expiry of the futures contract. Arbitrager will keep this arbitrage position open till the expiry day when the spot and futures start trading at parity. Once the prices converge, he will close both the positions and keep Rs 10 – Transaction charges as risk free profit.
1. Transaction charges and brokerage eats away the majority of arbitrage profit. Investors should always account for them
before taking the arbitrage position.
2. Sometimes spot price and future price do not converge on expiry date.
3. As soon as a company announces a dividend, the stock futures accounts for it by going ex-dividend, even before the stock becomes ex-dividend. In such a scenario, spot price and future price will not converge on expiry date leading to very less (which will be eaten away by transaction charges) or zero arbitrage profit. Hence, whenever the future price is trading at significant discount to the spot price, investors should double check the reason before taking the arbitrage position.
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