Cash future arbitrage strategy involves simultaneously buying a stock in the cash market and selling its future contracts, exploiting price differences between them. It’s a low-risk strategy aiming for profits when futures converge to the spot price at expiry, capitalizing on market inefficiencies.
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What is Cash Future Arbitrage?
Cash Future Arbitrage involves simultaneously buying stocks in the cash market and selling equivalent futures contracts, or vice versa, to profit from price differentials between these markets while maintaining a risk-neutral position.
This strategy exploits temporary price discrepancies considering the cost of carry, interest rates and dividend expectations. Traders calculate optimal position sizes based on price differences and execution costs.
Professional arbitrageurs monitor multiple stocks for opportunities, using automated systems to identify and execute trades quickly when price gaps exceed transaction costs and provide risk-free returns.
Cash Futures Arbitrage Example
In cash future arbitrage, if a stock trades at Rs. 100 in the cash market but at Rs. 105 in the futures market, an investor buys the stock for Rs. 100 and simultaneously sells a futures contract at Rs. 105, aiming to profit from the Rs. 5 difference.
Cash Future Arbitrage Formula
Cash-future arbitrage involves exploiting the price difference between a stock’s spot price (cash market) and its futures price to earn risk-free profit. This strategy works when the futures price is either overpriced or underpriced relative to the spot price.
The formula to identify the arbitrage opportunity is:
Arbitrage Formula: Futures Price – (Spot Price+Cost of Carry)
where;
Futures Price: The current price of the futures contract for the asset.
Spot Price: The current market price of the asset in the cash/spot market.
Cost of Carry: Costs associated with holding the asset until the futures contract expires, such as interest, storage and dividends (if applicable).
How Cash Future Arbitrage Works?
When futures trade at a significant premium to spot prices, traders buy stocks in the cash market and sell futures contracts. At expiry, futures converge with spot prices, generating profits from premium reduction.
Position monitoring requires tracking basis (difference between spot and futures), margin requirements and potential corporate actions. Risk management includes maintaining balanced positions and hedging costs.
Execution involves calculating fair futures prices using the cost of carry model, considering interest costs, expected dividends and transaction charges to determine profitable opportunities.
Cash Future Arbitrage Strategy
The strategy requires identifying optimal entry points when price differentials exceed transaction costs, maintaining balanced positions and managing execution across cash and futures markets efficiently.
Successful implementation involves continuous monitoring of price relationships, understanding the impact of corporate actions and maintaining adequate margins. Quick execution capabilities ensure capturing profitable opportunities.
Risk controls include position size limits, stop-loss levels for unexpected gaps and monitoring of carrying costs. Professional traders often automate calculations and executions for multiple stock-future pairs.
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Cash Future Arbitrage – Quick Summary
- Cash-future arbitrage strategy involves buying in the cash market and selling futures to exploit price differences, aiming for profit as futures converge to spot price by expiry, effectively capitalizing on market inefficiencies.
- In cash-future arbitrage, if a stock trades at ₹100 in cash and ₹105 in futures, buying in cash and selling in futures captures the ₹5 differential, yielding potential profit at convergence.
- Cash-future arbitrage exploits price disparities between spot and futures prices. The formula is Futures Price – (Spot Price + Cost of Carry), where cost includes interest, storage and dividends, identifying profitable opportunities.
- When futures trade at a premium to spot, traders buy in cash and sell futures. Monitoring basis, managing margins and calculating fair futures prices ensure gains as futures converge to the spot at expiry.
- The strategy involves entering when differentials exceed transaction costs, balancing positions and managing cash-futures execution. Professionals use automated tools for quick execution, maintaining margins and managing risk with stop-loss and position limits.
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Cash Future Arbitrage Meaning – FAQs
Cash Future Arbitrage captures price differentials between spot and futures markets by simultaneously buying in one market and selling in another, aiming for risk-free profits through price convergence at futures expiry.
When futures trade at a significant premium/discount to spot prices, traders take opposite positions in both markets. As prices converge at expiry, profit equals the initial price difference minus transaction costs.
Arbitrage Formula: Futures Price – (Spot Price+Cost of Carry)
where;
Futures Price: The current price of the futures contract for the asset.
Spot Price: The current market price of the asset in the cash/spot market.
Cost of Carry: Costs associated with holding the asset until the futures contract expires, such as interest, storage and dividends (if applicable).
Yes, but requires quick execution, adequate capital and consideration of transaction costs. Typical monthly returns range from 0.5-2%, depending on market conditions and price differentials.
Yes, arbitrage trading is completely legal and regulated in India. SEBI recognizes it as a legitimate strategy contributing to market efficiency and price discovery.
Returns typically range from 8-15% annually, varying with market volatility and interest rates. Higher returns are possible during volatile periods but require efficient execution and risk management.
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, commodity and hence we bring you the important topics and areas that you should know:
Disclaimer: The above article is written for educational purposes and the companies’ data mentioned in the article may change with respect to time. The securities quoted are exemplary and are not recommendatory.
