What is Reverse Cash and Carry Arbitrage

Arbitrage is a popular trading strategy that takes advantage of price discrepancies in different markets. One specific type—reverse cash and carry arbitrage—comes into play when the futures price of an asset is lower than its spot price. This strategy lets traders lock in a risk-free gain by selling now and committing to buy later at a lower price through futures. In this article, we explore how reverse cash and carry arbitrage works, its ideal market conditions, and the risks associated with it.

Reverse cash and carry arbitrage is a trading strategy employed when futures prices are lower than the spot prices. It entails selling the asset short in the spot market while on the same hand, buying a long position in the futures contract.

Reverse Cash and Carry Formula

Profit = Spot Price – Futures Price – (Cost of Borrowing + Transaction Costs)

The strategy is profitable when this value is positive.

Successful reverse cash and carry arbitrage depends on meeting several key market conditions:

• The futures price is lower than the spot price
  

• The asset is available for borrowing or short selling in the spot market
  

• The trader can calculate and cover carrying costs and transaction charges
  

• There is liquidity in both markets to execute positions simultaneously
  

The following example illustrates how reverse cash and carry arbitrage can generate a risk-free profit:

Let’s assume:

• Spot Price of Stock A = ₹1,000
  

• Futures Price of Stock A = ₹980
  

• Borrowing and Transaction Costs = ₹10

Strategy:

• Short sell Stock A in the spot market at ₹1,000
  

• Buy futures contract of Stock A at ₹980
  

• On expiry, deliver the stock bought through futures to cover the short position

Net Profit = ₹1,000 – ₹980 – ₹10 = ₹10 per share

This profit is locked in regardless of market movement after execution, assuming all costs are factored correctly.

Cash and carry and reverse cash and carry arbitrage differ in strategy and market outlook. Key distinctions include:

Several factors influence the profitability of arbitrage strategies, including:

Investors can use various tools and platforms to spot arbitrage opportunities effectively, such as:

• Arbitrage Calculators available on trading platforms
  

• Real-time spot vs futures comparison on NSE or broker terminals
  

• Excel models to calculate implied cost of carry and profitability thresholds
  

Reverse cash and carry arbitrage carries certain risks that traders should be aware of, including:

Although considered low-risk, this strategy requires precise execution and strong understanding of margin requirements and short-selling mechanisms.

Reverse cash and carry arbitrage is typically used by:

• Institutional investors with access to borrowing mechanisms
  

• Hedge funds and proprietary traders looking for risk-free profits
  

• Traders during volatile markets when futures prices occasionally fall below spot levels
  

Short selling and arbitrage in India are governed by specific regulations to ensure market integrity, including:

• Short selling must comply with SEBI guidelines
  

• Margin obligations must be fulfilled as per exchange norms
  

• Settlement is done via T+1 for equities and expiry for futures
  

Reverse cash and carry arbitrage is a powerful strategy when executed under the right conditions. It allows traders to benefit from pricing inefficiencies between the spot and futures markets. However, it involves multiple moving parts—short selling, futures contracts, transaction costs, and strict regulatory compliance. With careful planning and execution, it can yield low-risk returns in specific market situations.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.