Arbitrage fund is a fund that aims to provide capital
appreciation and regular income for its unit holders by
identifying profitable arbitrage opportunities between
the cash and derivative market segments as also through investment
of surplus cash in debt and money market instruments.
Arbitrage is a strategy that involves simultaneous buying and selling of equal
or comparable securities from at least two markets in order to profit
from the variation in their prices. What makes this strategy a low risk
one is the fact that both the buy and sell transactions precisely
balance each other, thus making them less vulnerable to market swings.
Buy stocks – sell futures is the most commonly used
arbitrage strategy in the Indian context. Such an arbitrage opportunity
arises when the price of a stock (in stock/cash/spot market) trades
at discount to the price of its futures contract (in
futures/derivatives segment). Thus, one can buy the stock from the cash market
at lower price and sell its futures contract at a higher price, the
profit being the difference between the futures price and cash price.
The difference between the spot and futures price narrows on or
before the expiry date (last Thursday of every month). The position is
then unwound to book the profit. For example, if a stock `ABC' is
bought at Rs. 200 and its futures is sold at Rs. 205, a return of Rs. 5 is
locked at the time of initiation of the trade. By the end of the expiry of
the trade, their prices converge to Rs. 210.
On unwinding the position (sell stock – buy futures), the
profit earned on the stock from the stock market is Rs. 10, while the
loss from the futures market is Rs. 5. Therefore, the net profit realized
is Rs. 5 (which was actually locked-in during the initiation of
the trade). Futures contracts are always traded in lots. Therefore, if
the futures contract of stock `ABC' has a lot size of 100 shares, the
total profit/return made on this strategy will be Rs. 500.
|
