what is cash and carry arbitrage
cash and carry arbitrage is a market neutral strategy combining the purchase of a long position in an asset such as a stock or commodity and the sale short of a position in a futures contract on that same underlying asset it seeks to exploit pricing inefficiencies for the asset in the cash or spot market and futures market in order to make riskless profits the futures contract must be theoretically expensive relative to the underlying asset or the arbitrage will not be profitable basics of cash and carry arbitragein a cash and carry arbitrage the arbitrageur would typically seek to carry the asset until the expiration date of the futures contract at which point it would be delivered against the futures contract therefore this strategy is only viable if the cash inflow from the short futures position exceeds the acquisition cost and carrying costs on the long asset position cash and carry arbitrage positions are not 100 without risk as there is still risk the carrying costs can increase such as a brokerage raising its margin rates however the risk of any market movement which is the major component in any regular long or short trade is mitigated by the fact that once the trade is set in motion the only event is the delivery of the asset against the futures contract there is no need to access either one in the open market at expiration physical assets such as barrels of oil or tons of grain require storage and insurance but stock indexes such as the s p 500 index likely require only financing costs such as margin therefore arbitrage may be more profitable all else held constant in these non physical markets however because the barriers to participate in arbitrage are much lower they allow more players to attempt such a trade the result is more efficient pricing between spot and futures markets and lower spreads between the two lower spreads mean lower opportunities to profit less active markets may still have arbitrage possibilities as long as there is adequate liquidity on both sides of the game spot and futures example of cash and carry arbitrageconsider the following example of cash and carry arbitrage assume an asset currently trades at 100 while the one month futures contract is priced at 104 in addition monthly carrying costs such as storage insurance and financing costs for this asset amount to 3 in this case the arbitrageur would buy the asset or open a long position in it at 100 and simultaneously sell the one month futures contract i e initiate a short position in it at 104 the trader would then hold or carry the asset until the expiration date of the futures contract and deliver the asset against the contract thereby ensuring an arbitrage or riskless profit of 1 