What is Cash and Carry Arbitrage?

In a market where prices move every second, most trading strategies thrive on volatility. But there’s one that actually depends on price inefficiency—and that's Cash and Carry Arbitrage.

Often used by professional traders and institutions, this strategy allows you to lock in small, low-risk profits when the spot price and the futures price of an asset diverge. The trick lies in playing both sides at once.

What Is Cash and Carry Arbitrage?

At its core, Cash and Carry Arbitrage is a market-neutral trading strategy where an investor:

1. Buys an asset in the cash (spot) market, and
2. Sells a futures contract on the same asset simultaneously.

The goal is to capture the price difference between the two markets. When the futures contract expires, the investor delivers the asset, closing both positions and pocketing the profit.

🧮 Real-Life Example

Let’s say you spot a mismatch:

• Current price of Stock A (spot) = ₹1,000
• 1-month futures price of Stock A = ₹1,030
• Lot size = 100 shares

Here’s what you do:

1. Buy 100 shares of Stock A in the cash market = ₹1,00,000
2. Sell 1 futures contract at ₹1,030 = ₹1,03,000
3. On expiry, deliver the shares to settle the futures contract.

Your locked-in profit = ₹3,000 (before transaction and holding costs)

⚙️ Why Does This Price Difference Happen?

Futures usually trade at a premium to the spot price due to what’s called the cost of carry. This includes:

• Interest on borrowed capital
• Storage or holding costs
• Dividend expectations
• Market demand and supply

When the difference between the futures and spot price exceeds the cost of carry, it opens the door for arbitrage.

🎯 When to Use This Strategy

• When futures prices are trading noticeably higher than spot prices
• You can access low-cost capital
• You have the capacity to hold the asset until futures expiry

This strategy is most commonly applied in index futures like Nifty or Bank Nifty, or in large-cap stocks with liquid futures contracts.

🧠 Key Benefits

✅ Low risk – Since you hold opposite positions, market movements don’t impact you.
✅ Predictable returns – The profit is almost guaranteed (assuming costs are managed).
✅ Market neutral – No need to guess market direction.

⚠️ What Are the Risks?

While relatively safe, cash and carry arbitrage isn’t risk-free. Here’s what to watch out for:

• High transaction costs (brokerage, taxes, exchange fees)
• Interest or borrowing costs if you're trading on margin
• Illiquidity in the futures contract
• Corporate actions like dividends or stock splits that affect pricing
• Execution delay between spot and futures trades

🔍 Cash and Carry vs Reverse Arbitrage

There’s also a flip side—called Reverse Cash and Carry Arbitrage—used when futures are cheaper than the spot price. In that case, you sell the asset in the cash market and buy in the futures market to profit.

👨‍💼 Who Uses This Strategy?

• Institutional investors with access to large capital
• Hedge funds focused on market-neutral strategies
• Experienced traders managing proprietary desks

Retail investors can use this strategy too, but need to account for higher costs and limited capital.

📊 Final Thoughts

Cash and carry arbitrage is like finding a mispriced product in two stores and profiting from the difference. The key is speed, discipline, and careful cost management.

While it won’t make you a millionaire overnight, it’s one of the few strategies in the market that rewards patience over prediction.

 

FAQs:-

Q1. Is cash and carry arbitrage profitable for retail investors?
Yes, but only if transaction and funding costs are low. Otherwise, the small margin might be wiped out.

Q2. Is it legal to do arbitrage trading in India?
Absolutely. Arbitrage trading is legal and practiced on exchanges like NSE and BSE.

Q3. Can arbitrage lead to losses?
In rare cases, yes—mainly due to execution delays, unexpected corporate actions, or cost miscalculations.