Cash-and-Carry-Arbitrage

What is Cash-and-Carry-Arbitrage

Cash-and-carry-arbitrage is a market-neutral strategy consolidating the purchase of a long position in an asset like a stock or commodity, and the sale (short) of a position in a futures contract on that equivalent underlying asset. It looks to take advantage of pricing failures for the asset in the cash (or spot) market and futures market, to create riskless gains. The futures contract must be hypothetically costly relative to the underlying asset or the arbitrage won't be profitable.

Fundamentals of Cash-and-Carry-Arbitrage

In a cash-and-carry-arbitrage, the arbitrageur would ordinarily look to "carry" the asset until the expiration date of the futures contract, at which point it would be delivered against the futures contract. Consequently, this strategy is just suitable in the event that the cash inflow from the short futures position surpasses the acquisition cost and carrying costs on the long asset position.

Cash-and-carry arbitrage positions are not 100% without risk as there is still risk the carrying costs can increase, for example, a brokerage raising its margin rates. Nonetheless, the risk of any market movement, which is the major part in any normal long or short trade, is alleviated by the way that once the trade is set moving the main event is the delivery of the asset against the futures contract. There is compelling reason need to access possibly one in the open market at expiration.

Physical assets, for example, barrels of oil or lots of grain require storage and insurance, yet stock indexes, like the S&P 500 Index, reasonable require just financing costs, like margin. In this way, arbitrage might be more profitable, all else held steady, in these non-physical markets. Be that as it may, in light of the fact that the barriers to take part in arbitrage are a lot of lower, they permit more players to endeavor such a trade. The outcome is more efficient pricing among spot and futures markets and lower spreads between the two. Lower spreads mean lower opportunities to profit.

Less active markets might in any case have arbitrage prospects, for however long there is adequate liquidity on the two sides of the game — spot and futures.

Illustration of Cash-and-Carry Arbitrage

Think about the accompanying illustration of cash-and-carry-arbitrage. Expect an asset at present trades at $100, while the one-month futures contract is priced at $104. What's more, month to month carrying costs like storage, insurance, and financing costs for this asset amount to $3.

In this case, the arbitrageur would buy the asset (or open a long position in it) at $100 and simultaneously sell the one-month futures contract (for example start a short position in it) at $104. The trader would then hold or carry the asset until the expiration date of the futures contract and deliver the asset against the contract, in this manner guaranteeing an arbitrage or riskless profit of $1.

Features

• Cash-and-carry-arbitrage isn't altogether without risk since there might be expenses associated with physically "carrying" an asset until expiry.
• Cash-and-carry arbitrage looks to take advantage of pricing failures among spot and futures markets for an asset by going long in the spot market and opening a short on the futures contract.
• The thought is to "carry" the asset for physical delivery until the expiry date for the futures contract.