What are the advantages of using cash and future arbitrage?
#01 – Reasonable Returns When No Other Trade is visible
This strategy can offer 18-22% returns annually for traders when there are no trades visible on horizon. This is a much better option than keeping funds at no interest with the broker, or even keeping them in your saving account. Good traders are like music; they flow very simple and naturally. Often the stresses of running a household, peer pressure, etc, can lead a trader into a false trade. In my years of trading, I have found that the best trading is done when there is no pressure which is why I spend a lot of time looking for opportunities which can help me make money from activities other than pure swing trading. Cash futures arbitrage is one such; writing covered calls is another. Returns of 18 to 22% annually many not excite stock market punters, but stock market trading is as much about stability and consistency of returns as it is about the quantum of returns on every trade. These are all issues professional traders need to think about. These extra returns take some pressure off the need to trade all time, thus enabling the trader to wait for the best setups, confident that he is making money somewhere else.
#02 – Perfect for cash which you cannot risk
All traders have cash which they do not want to directly risk in the stock market. Cash futures arbitrages can be a technique to earn a decent risk free return on cash that cannot be risked. All traders keep some reserve cash or an account where they keep profits for times when the stock market stop being helpful. These funds can be deployed in risk free strategies such as cash future arbitrage.
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| Advantages of Cash & Future Arbitrage |
#03 – Perfect for choppy sideways markets
Markets go through periods of consolidation and up and down action when trading becomes very difficult. The costs of carry of futures are reasonable till about 15th of every month. So it’s always possible to wait a few days if one has to till some extraordinary mispricings appear. These mispricings are very quickly taken care of by smart arbitrageurs, so waiting one you spot such an opportunity is not the smartest thing to do.
#04 – Reduces the market risk of portfolio
A lot of high net worth investors and mutual funds have very high weightage in index stocks. These are times when the market might look overheated and these investors may want to reduce the risk of possible market declines for the next few weeks. At such times they can sell index futures worth the entire or a part of the market value of their portfolio to hedge against market declines and also earn the cost of carry in the bargain. Index futures arbitrage may not be profitable for individual trader because of the inefficiencies in buying the cash nifty or the sensex portfolio.
Although it is possible to buy the nifty cash portfolio through the nifty basket, which is a portfolio of nifty stocks bought by shooting bids at all the stocks in the weightages that they represent in the nifty. But the overall acquisition price of the nifty bees may turn out to be higher than the nifty cash at the same point since some of the nifty constituents are not liquid at all times. In such case, if trader wants to invest Rs. 10 lakh in index arbitrage, he can buy Rs. 10 lakh worth of nifty bees and sell an equivalent amount of nifty index future. But traders purely in the arbitrage game for the cost of carry returns will not find the nifty premiums too exciting.
The other option is buying the nifty bees, which is product by a company which closely tracks the nifty. The bees trade at one tenth the value of the cash nifty. But the liquidity is so poor that serious traders cannot trade a large quantity.
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