Definition
Reverse Arbitrage
Reverse arbitrage is the cash-futures arbitrage variant of shorting the cash market and buying the future when the future trades below fair value, constrained in India by limits on cash-market short selling.
Standard cash-futures arbitrage is long cash, short future when the future is rich. Reverse arbitrage does the opposite when the future is cheap, but it requires shorting the cash leg, which Indian rules permit only intraday unless shares are borrowed via SLB.
Because multi-day cash shorting is hard, reverse arbitrage is far less common than the standard direction, and a persistently negative basis can survive longer than a positive one. This asymmetry is a structural feature of the Indian market that shapes the behaviour of arbitrage funds.
Related terms
- 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.
- Cash-Futures ArbitrageCash-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.
- 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.
- Basis (Futures)Basis is the difference between the futures price and the spot price of the underlying, reflecting the cost of carry and market expectations, and it converges to zero as the contract approaches expiry.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.