Futures prices vs. Arbitrage

General
1

There are two types of arbitrage possible with stock futures,

  1. Cash-and-carry arbitrage (profitable when futures price is higher than CNC price)
  2. Reverse cash-and-carry arbitrage (profitable when futures price is lower than CNC price)

Hence, there’s opportunity for profit whenever futures price deviates too far from CNC prices in both directions. Why then do futures prices sometimes deviate far from CNC prices? Wouldn’t arbitrageur always balance things out so the futures price is always near CNC prices?

2

1.) Cash and Carry: In this type, the future price don’t go much far from cash price. As taking advantage of arbitrage is simple and easy. You may see a gap of 0.8% for a future contract expiring after 30 days. If you go for the arbitrage trade, you will pay 0.3% as cost (STT, Slippage) etc. So only earn 0.5%

This gap no one wants to arbitrage, because, 0.5% for 30 days is 6% per year. They can get 6% every year from a lot other things.

2.) Reverse cash and carry: In this, you will see bigger gap than 1%, even 2-3%. But it is not simple to take arbitrage trade. We need to buy in future and short in cash. Shorting in cash can only be done using SLB. SLB has its own cost (interest rate), more margin required etc.