Cash & Carry Candidates

Cash and carry arbitrage is a combination of buying an asset such as stock and at the same time selling the futures contract of the same stock. With the help of an example let’s understand the benefits of cash and carry arbitrage and what needs to be done, in order to execute the same

On the 3rd of July, Nestle India was trading on the NSE at Rs.3637.2/ share. The company’s shares trades on the futures counter as well. The near month (expiring on 27th July) futures contract was trading at Rs.3713.85. The lot size of the company in futures market is 200. Let’s suppose a trader can borrow money from banks at an interest rate of 6.55% per annum and invest the same in stock and futures market

Here’s a recap of all the data:

Spot price of Nestle India : Rs.3637.2
Future price of Nestle India : Rs.3713.85
Days to expiry of the futures contract : 27/07–03/07 = 24 days
Lot size : 200 shares

Lets now try to calculate the fair value of the futures contract.

Fair value = Spot price * Exp (rate of interest * time to expiry)
= 3637.2 * Exp (6.55% * (24/360))
= Rs.3653.12

Fair value spread = future price — future fair value = 3713.85–3653.12 = Rs. 60.73.

As learnt earlier a positive fair value spread highlights cash and carry arbitrage opportunity. Now, lets see how that can be carried out.

First the trader buys / goes long on 200 shares of Nestle India at the current price. Why 200? Because the lot size of Nestle India in the futures market is 200 and he needs to match the same. The cost of this transaction is 200*3637.2 = Rs.7,27,440.0. Let’s assume the trader borrowed this amount from the bank to invest in the stock. At the same time he sells / shorts 1 Nestle India futures contract with lost size of 200 shares.

Case 1: Now let’s suppose on the day of futures expiration i.e 27th July, stock is trading at Rs.3800

Profit on long position = (3800–3637.2 ) * 200 = Rs.32,560

Loss on short position = (3713.85–3800) * 200 = Rs.17,230

Combined P/L of long and short position = 32,560–17,230 = 15,330

Cost of borrowing funds to invest into stocks = [7,27,440 * Exp(6.55% * (24/360)) — 7,27,440]= Rs.3,183.43

Total profit from the transaction = 15,330–3,183.43 = Rs.12,146.57

Case 2: Let’s also look at scenario where stock price of Nestle India falls to Rs.3400 on 27th July

Loss on long position = (3400–3637.2) * 200 = Rs. 47,440

Profit on short position = (3713.85–3400) * 200 = Rs. 62,770

Combined P/L of long and short position = 62,770–47,440 = 15,330

Cost of borrowing funds to invest into stocks = [7,27,440 * Exp(6.55% * (24/360)) — 7,27,440]= Rs.3,183.43

Total profit from the transaction = 15,330–3,176.5 = Rs.12,146.57

So irrespective of the price movement, you will always make a profit of Rs 12,146.57 by executing the above explained cash and carry trades. There is a very easy way to calculate cash and carry profit without going into all the details. Earlier we have calculated the fair value spread to be 60.73 (difference between current price of the future contract and the fair value). If you multiple the fair value spread with lot size, you will get the same profit = 60.73 * 200 = 12146. So to spot cash and carry opportunities, one needs to look for high fair value spread.

Please note that, trading cost will be extra and you need to ensure that cash and carry profit is more than the trading cost to successfully execute the strategy