Cash and Futures Arbitrage

Hi Guys!

I wanted to get opinions and advice on arbitrage opportunities in Indian markets. Arbitrage is basically risk free return on account of mis-priced instruments/securities. Every instrument has its fundamental value, and if it deviates from this value, we have an arbitrage opportunity.

One of the most basic arbitrages are in cash-futures pair of underlying equity.
Mathematically,



This assumes that you can invest your capital at a continuously compounded risk free rate for the expiry days left. But we (as common retail investors) don't necessarily have access to a risk free rate to which general market has. For us, our opportunity cost of capital is the Fixed Deposit (FD) return, and the quoted FD return is not continuously compounded. If we make an assumption that FD rate is 10% compounded annually, the corresponding continuously compounded rate is 9.53%.

So, for us as retail investors, to benefit from the arbitrage opportunities, the fundamental futures price should be:



There is a arbitrage opportunity if futures price deviates from this price. To make it simpler, we can just look at the % premium/discount. A fairly priced future should have a premium of :



If the premium is more or less than this, there is an arbitrage opportunity. Keep in mind that this will be the minimum alpha you can make by arbitrage, because mis-pricing can vanish before expiry, making your annualized alpha more than these calculations.

Any opinions, suggestions, observations etc are welcome.

Thanks!

PS : Simple Excel calculator

Premium on 14th May 2015 is about 0.41%.

Mis-priced futures (yesterday's closing) :

Titan Company : -1% discount (0.6% holding period alpha)

JP Power : 1.2% premium (0.8% holding period alpha)

Do you have a specific question?

JP power is a Rs.8 stock. 1% premium is 8p. The bid ask spread itself is 5p

Specific question was regarding the viability of this strategy. If anyone has done it consistently, can share the views.

For JPP, yesterday closing premium was 10p, today got reduced to 5p. Have to manage around bid-ask spread to get the desired width.

I tried PNB yesterday, width got reduced from about 220 p in the morning to 160 by the closing. At market, width got reduced by 15p, but if you can take a little risk and put limits accordingly (keeping in mind 10-20 p oscillations) , full width can be taken.

PS : Is there any freely available screener which can screen according to futures premia?

do you have an excel sheet for the calculation?

Screener : no idea.

Not yet, since mostly back of the envelope calcs.

What specific calculation are you refering to?

the one mentioned in your first post.

Attached the link in the first post. It's pretty basic calculator that I just made.

nice. thanks.

with regards to days to expiry, are you taking calendar days or business days?
do you look at opportunities on EOD basis or intraday basis?

If you can link NOW/NEST to excel feed, you can have real time tracking for this kind of opportunity.

But, you are looking for .5% as your benchmark for arbitrage opportunities?


thanks.

I am taking calendar days. Opportunities on EOD basis as of now, because I don't yet have real time feed on future premia, best will be intraday though.

I will try linking up for real time opportunities.

0.5% is alpha benchmark because I think for meaningful intraday arbitrage, difference should be wide (as the full gap might not close in one day, more the gap...more opportunity for tightening in a single day) . But if you are carrying your positions overnight, then 0.4-0.5% is not a bad range.