What is Arbitrage and difference between Cash price and Future Price

*What is Arbitrage and difference between Cash price and Future Price*

🎯 *What is Arbitrage*

📌Arbitrage describes the act of buying a security in one market and simultaneously selling it in another market at a higher price, thereby enabling investors to profit from the temporary difference in cost per share.

📌An arbitrage fund is a type of mutual fund that appeals to investors who want to profit from volatile markets without taking on too much risk. This schemes look to exploit the price difference between spot and futures market to earn risk  free returns.

🎯 *Why is there gap between cash price & future price*

📌Stock futures have a monthly expiry cycle and expire on the last Thursday of every month.

📌In stock-futures arbitrage you buy in the cash market and sell the same stock in the same quantity in the futures market. Since the futures price will expire at the same price as the spot price on the F&O expiry day, the difference becomes the risk-free spread for the arbitrageur. 

📌Futures price pertain to a contract that is 1 month down the line there is a cost of carry; also, roughly known as the interest cost. So, let assume,  if the annual risk-free rate of interest is 12% then the 1-month future's price must be at a 1% (12%/12) premium to the cash price. Of course, in reality the futures price is determined by a variety of other factors, but this is the key factor. Therefore, by buying in the cash market and selling in the futures you lock in that 1% returns per month.

📌For example of CYZ stocks Cash price 28th June 2020 100, while 28th July, Future price is 101. So,the Arbitrage spread is {(101-100)/100}, which is 1% that is return of 30 days. So annualised return in this case is 1% × (365/30) =12.16%.

"Mutual Fund investments are subject to market risk kindly read all scheme related documents carefully"