Nifty Futures always better than Mutual Funds

One of the best arbitrage kinds of opportunities is available in the Indian capital markets owing to the mispricing of nifty futures. In developed markets, the cost-of-carry is usually linked closely with the prevalent interest rates and the minutest amount of mispricing is quickly captured by arbitrageurs. But in Indian markets, especially in the derivatives segment, the number of speculators and traders is far more than the number of arbitrageurs. So the difference in underlying and futures prices is far more dependant on the current sentiment in the market than on interest rates. Note that my observation is restricted to nifty and nifty futures. I’m not aware situation in individual stocks.

Cost of carry for far month contracts generally has been negative. If not that, even then far month contracts tend to trade a few points below the near month contracts. Ideally speaking, it should be opposite. One can hold long a lot of nifty worth two lakh rupees with a margin of thirty thousand and invest rest of the 1,70,000 in a nine percent fixed deposit. Every month, roll over the position to the next month’s contract effectively capturing 20-25 points. Do the roll-over on a day when market goes down a lot. That is when speculators are busy shorting and opportunities are more. This way one can make 6% in FD and 6% in roll-overs for a total of up to 12% excess returns over nifty with minimal risk. This performance will beat most of the mutual fund returns.

One more reason why this opportunity exists and cannot be easily cashed by the arbitrageurs is because short-selling is not allowed and brokerage costs are high when trading in equities.

So my strategy is to hold a nifty futures position, roll it over on bad days to make use of the negative cost of carry, put free funds in a fixed deposit that is flexible enough to provide for the down-times. I think this will always beat the market by at least 10% per annum and be better than most of the mutual funds. Derivative experts, please let me know your views.

Have you backtested your strategy on past data. I will be interested in knowing the results. If it has made money on paper trade /simulated trade then it might be worth considering.
At first glance, I am not so convince because market price of Nifty Futures does not follow mathematical forumla in real life. At certain times it is at discount and other times, it is at premium.

Happy Trading