Arbitrage

An arbitrageur is basically risk averse. He enters into those contracts were he can earn riskless profits. When markets are imperfect, buying in one market and simultaneously selling in other market gives riskless profit. Arbitrageurs are always in the look out for such imperfections.

In the futures market one can take advantages of arbitrage opportunities by buying from lower priced market and selling at the higher priced market. In index futures arbitrage is possible between the spot market and the futures market (NSE has provided a special software for buying all 50 Nifty stocks in the spot market.

  • Take the case of the NSE Nifty.
  • Assume that Nifty is at 1200 and 3 month’s Nifty futures is at 1300.

  • The futures price of Nifty futures can be worked out by taking the interest cost of 3 months into account.

  • If there is a difference then arbitrage opportunity exists.

Let us take the example of single stock to understand the concept better. If Wipro is quoted at Rs 1000 per share and the 3 months futures of Wipro is Rs 1070 then one can purchase Wipro at Rs 1000 in spot by borrowing @ 12% annum for 3 months and sell Wipro futures for 3 months at Rs 1070.

Sale                = 1070

Cost= 1000+30 = 1030

Arbitrage profit =    40

These kind of imperfections continue to exist in the markets but one has to be alert to the opportunities as they tend to get exhausted very fast.

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