# Reverse Cash and Carry arbitrage

08 May 2017 Nilesh Jain

New Page 1

Reverse Cash and Carry arbitrage is a combination of short position in underlying asset (cash) and long position in underlying future. It is initiated when future is trading at a discount as compared to cash market price. In other words, the cash market price is trading higher as compared to future. The arbitrageur/ trader can take position by selling his delivery of stocks in cash and simultaneously buying futures of same underlying assets of equal quantity. A trader must have delivery in that particular stock when there is such an opportunity available in the market.

Reverse cash and carry arbitrage occurs when market is in "Backwardation", which means future contracts are trading at a discount to the spot price.

Let’s try to understand with the help example of CEATLTD as on 26th APRIL 2017:

As we can see in the above illustration from 5paisa terminal there was a price difference between cash market price and May futures price of Rs 60.

 Cash market price (as on 26th April 2017) (S) Rs 1570 May Futures (Expiry on 29th May 2017) (F) Rs 1510 Contract size 700 Rate of Interest 9% (p.a.) Time to expiry (n) 29 days Amount received from selling Delivery of CEAT Rs 10,99,000 (1570*700) Margin required to sell futures Rs 1,37,595 Free cash available Rs 9,61,405 Fair value is measured by the formula S= F/(1+R)^n Lending rate 0.72% Basis Spot price-Future price

Free cash available to lend will be Rs 10,99,000 - Rs 1,37,595 = Rs 9,61,405

Gain from amount lend is Rs 6,874.71 (9,61,405*(0.09^(29/365)))

S= 1510/(1+0.09)^(29/365)

Fair Value of spot price (S)= 1500

Current spot price= 1570

Hence, we can see that there is an arbitrage opportunity.

Risk free Arbitrage=Rs 70 (1570-1500)

To take advantage from this mispricing, trader/arbitrageur will buy futures at Rs 1510 and sell CEATLTD in cash market at Rs 1570. This would result in gross arbitrage profit of Rs 42,000 (60*700). And income received from lended amount would be Rs 6874.71, so Net arbitrage profit would be Rs 48,874.71.

Scenario analysis:

Case 1: CEATLTD rises to 1620, at expiry

Loss on underlying (cash) = (1620-1570)*700= (Rs 35,000)

Profit on futures = (1620-1510)*700= Rs 77,000

Gross Gain on Arbitrage= Rs 42,000

Inflow from lending: Rs 6874.71

Net gain from arbitrage: Rs 48,874.71

Case 2: CEATLTD falls to 1450, at expiry

Profit on underlying (cash) = (1570-1450)*700= Rs 84,000

Loss on Futures= (1510-1450)*700= (Rs 42,000)

Gross Gain on Arbitrage= Rs 42,000

Inflow from lending: Rs 6874.71

Net gain from arbitrage: Rs 48,874.71

To round up, in any reverse cash and carry arbitrage, the moment you trigger this arbitrage, your profit is fixed depending upon the arbitrage opportunity. This is also called risk free arbitrage because your profit is secured irrespective of underlying price movement.

Whenever future price of an underlying asset are higher than the current spot price, a cash and carry arbitrage opportunity arises.

Similar Articles
• Responses
• ### Patidar Samaj

- 2 hrs ago

This article claims RJio was given a "Backdoor Entry" into the 4G Based Voice Routing. The peculiar aspect is without the Voice License, Rjio would have been a mere ISP. With the license, it is now a holistic communications service provider, with ability to exponentially scale the bouquet of products. The events indicate it was meticulously planned way before the auctions because the auctions were clear on the agenda: 4G for internet only.

Have Referral Code?

# Reverse Cash and Carry arbitrage

08 May 2017 Nilesh Jain

New Page 1

Reverse Cash and Carry arbitrage is a combination of short position in underlying asset (cash) and long position in underlying future. It is initiated when future is trading at a discount as compared to cash market price. In other words, the cash market price is trading higher as compared to future. The arbitrageur/ trader can take position by selling his delivery of stocks in cash and simultaneously buying futures of same underlying assets of equal quantity. A trader must have delivery in that particular stock when there is such an opportunity available in the market.

Reverse cash and carry arbitrage occurs when market is in "Backwardation", which means future contracts are trading at a discount to the spot price.

Let’s try to understand with the help example of CEATLTD as on 26th APRIL 2017:

As we can see in the above illustration from 5paisa terminal there was a price difference between cash market price and May futures price of Rs 60.

 Cash market price (as on 26th April 2017) (S) Rs 1570 May Futures (Expiry on 29th May 2017) (F) Rs 1510 Contract size 700 Rate of Interest 9% (p.a.) Time to expiry (n) 29 days Amount received from selling Delivery of CEAT Rs 10,99,000 (1570*700) Margin required to sell futures Rs 1,37,595 Free cash available Rs 9,61,405 Fair value is measured by the formula S= F/(1+R)^n Lending rate 0.72% Basis Spot price-Future price

Free cash available to lend will be Rs 10,99,000 - Rs 1,37,595 = Rs 9,61,405

Gain from amount lend is Rs 6,874.71 (9,61,405*(0.09^(29/365)))

S= 1510/(1+0.09)^(29/365)

Fair Value of spot price (S)= 1500

Current spot price= 1570

Hence, we can see that there is an arbitrage opportunity.

Risk free Arbitrage=Rs 70 (1570-1500)

To take advantage from this mispricing, trader/arbitrageur will buy futures at Rs 1510 and sell CEATLTD in cash market at Rs 1570. This would result in gross arbitrage profit of Rs 42,000 (60*700). And income received from lended amount would be Rs 6874.71, so Net arbitrage profit would be Rs 48,874.71.

Scenario analysis:

Case 1: CEATLTD rises to 1620, at expiry

Loss on underlying (cash) = (1620-1570)*700= (Rs 35,000)

Profit on futures = (1620-1510)*700= Rs 77,000

Gross Gain on Arbitrage= Rs 42,000

Inflow from lending: Rs 6874.71

Net gain from arbitrage: Rs 48,874.71

Case 2: CEATLTD falls to 1450, at expiry

Profit on underlying (cash) = (1570-1450)*700= Rs 84,000

Loss on Futures= (1510-1450)*700= (Rs 42,000)

Gross Gain on Arbitrage= Rs 42,000

Inflow from lending: Rs 6874.71

Net gain from arbitrage: Rs 48,874.71

To round up, in any reverse cash and carry arbitrage, the moment you trigger this arbitrage, your profit is fixed depending upon the arbitrage opportunity. This is also called risk free arbitrage because your profit is secured irrespective of underlying price movement.

Whenever future price of an underlying asset are higher than the current spot price, a cash and carry arbitrage opportunity arises.