There are many words in futures and option trading which looks difficult to understand but when you read about them, they are quite simple. One of them is Reverse Cash and Carry Arbitrage.
We will discuss definitions of it and related words to it with example. However, To discuss this technique, first we need to understand the arbitrage.
Table of Contents
What is Arbitrage?
Arbitrage is an essential word in stock market. It relates to the steps of purchasing a stock or commodity in one segment and selling it in another at a better price at the same time.
Arbitrage is meaningful in the pricing of derivative segment such as options and futures. There are various arbitrage techniques, one of which is reverse cash and carry arbitrage.
Before jumping into the meaning of reverse cash and carry arbitrage, let’s understand cash and carry arbitrage.
What is Cash and Carry Arbitrage?
You may aware that the futures contract and the current market price will come at same price on the end of the futures expiry date, However, they are not traded at same price during the the days before expiry or on expiry.
When the cost of the future is significantly high than the cost of the current market price, or the basic asset, a trader should short the futures contract and long the current market price leading up to the expiry date. 
Also Read: Derivative Trading
What is Reverse Cash and Carry Arbitrage?
The flip side of cash and carry arbitrage is reverse cash and carry arbitrage. When the cost of the future is significantly lower than the cost of the current market price, or the basic asset, a trader should long the futures contract and short the current market price leading up to the expiry date.
It is an approach that combines an asset’s short and long futures positions. It allows a trader to get profit from the contradictory rates opportunity among cash and futures rates of the same asset underlying.
Example
Here’s an illustration of a reverse carry arbitrage: An stock is currently trading at INR 205, although the one-month futures contract is trading at INR 200. Suppose that the costs of maintaining the short position price to INR 2.
As a result, a trader would open a short position at INR 205 and a futures position at INR 200. When the future contract matures, the trader accepts the asset delivery and uses it to protect the asset’s short position.
As an outcome of this, the trader earns INR 3 (205-200- 2 = 3)
Reasons for Price Difference
Price fluctuations Between Future and Current market price could occur for a many of reasons.
- Dissimilarities in trading periods
- Authorities controls on some exchanges
- Availability of stock in a specific country
- News regarding that stock
The different pricing is what drives arbitrage, which is fundamentally all about leveraging the discrepancy among the Current price and future contract of stock or commodity.
Difference between both Arbitrage
| Cash and Carry Arbitrage | Reverse Cash and Carry Arbitrage |
| You buy future in Cash and Carry Arbitrage | You short Future in Reverse Cash and Carry Arbitrage |
| You short the current market price in Cash and Carry Arbitrage | You Buy the current market price in Reverse Cash and Carry Arbitrage |
| Contango is the word used to describe a scenario in which the future price is higher than the current market price. | Backwardation is the word used to describe a scenario in which the future price is lower than the current market price. |
Conclusion
Arbitrage techniques are essential for anybody participating in trading in the futures or derivatives markets. However, lots of attention is required to understand the full concept of Futures and options.
This is all from our side regarding it. Although, if you have any doubts about reverse arbitrage trading you can just comment below.
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FAQ
Reverse arbitrage process?
In the process of Reverse arbitrage you buy current market price and short the future.
Arbitrage meaning?
Arbitrage means you buy a stock or commodity at one place and selling to another place where price is better.
Reverse cash and carry arbitrage meaning in Hindi?
आप मौजूदा बाजार मूल्य पर स्टॉक या कमोडिटी खरीदते हैं और वायदा कारोबार में कम पर बेचे।
Arbitrage meaning in hindi?
आर्बिट्रेज का मतलब है कि आप एक जगह पर स्टॉक या कमोडिटी खरीदते हैं और दूसरी जगह बेचते हैं जहां कीमत बेहतर होती है।
Term to Describe the scenario when Furture price is lower than current market price?
Backwardation is word to describe this situation.
