Cash & Carry Arbitrage

What is Cash & Carry Arbitrage?

First things first, let's first understand the concept of arbitrage. The arbitrage opportunity exists because of Market inefficiencies. It is the process of simultaneous buy and sale of shares to profit from the difference in the price of Underlying assets. The process seeks to exploit pricing inefficiencies for the Underlying Asset and the financial derivative corresponding to it.

Similarly, cash and carry arbitrage strategy involve the exploitation of the mispricing between an underlying asset and the financial derivative corresponding to it. Using this method, a trader aims to use the difference in the market price between the underlying assets and the derivative by exploiting the opportunity to generate profits.

How Cash & Carry Arbitrage Works?

Ideally, cash and carry arbitrage is a combination of long position (underlying assets) and short positions (underlying futures). The opportunity arises when the future prices of an underlying asset are higher than the current spot price. So, to make profits by using the cash and carry arbitrage, the difference between the spot price and future price should be slightly higher so that you can cover earn profit, transaction cost and financing cost.

In this strategy, a trader keeps the commodity for a long-term in the short position for the corresponding derivative and selling it off.

Traders shorten the corresponding contract and lock in a sale at the contract price. Consequently, the trader has to determine the sale, purchase of which is the contract is priced at. If the purchase price of the underlying along with the carrying cost is less than the price in which the contract is sold, then

The profit earned by the trader is figured out on the Basis of the purchase price of the underlying plus its entire carrying cost.

The commodity purchased is kept until the expiration date. Traders think that cash & carry arbitrage is a risk-free, however, it cannot be fully risk-free as there can be expenses associated with physically carrying an asset until expiration.