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

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

Code:

`http://speedy.sh/e7dxY/Cash-vs-Future-arbitrage.xlsx`

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