Definition
Cash-Futures Arbitrage
Cash-futures arbitrage profits from the gap between a stock's cash price and its futures price relative to fair value, capturing the cost-of-carry by holding the cash position against an offsetting futures position.
An Indian arbitrageur buys a stock in the cash market and simultaneously sells its future when the future trades above fair value, then unwinds at expiry as the two converge, earning a near-riskless spread minus costs. The reverse (reverse arbitrage) requires shorting the cash leg, which is constrained without SLB.
This strategy ties the clearing, margin and settlement systems together and is a staple of arbitrage funds and prop desks. Returns depend on the carry spread, financing costs and transaction charges; in India, the limited ability to short cash makes long-cash, short-futures arbitrage far more common than the reverse.
Related terms
- Market-Neutral StrategyA market-neutral strategy balances long and short positions so that the portfolio has little or no net exposure to broad market movements, isolating the manager's stock-selection skill.
- Securities Lending and Borrowing (SLB)Securities Lending and Borrowing is a regulated mechanism that lets investors lend their shares for a fee to borrowers who need them, typically to facilitate short selling or settlement.
- Index ArbitrageIndex arbitrage exploits price differences between an index's futures and the basket of its underlying stocks (or an ETF), buying the cheaper and selling the dearer to capture the convergence.
- Cost of CarryCost of carry is the net cost of holding an asset to a future date, comprising financing cost less any income, and it determines the fair-value difference between a futures price and the underlying spot price.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.