Arbitrage

Arbitrage is a trading strategy that exploits price differences for identical or equivalent assets across different markets or forms. A true arbitrage opportunity is theoretically risk-free because the buy and sell happen simultaneously, locking in a profit from the price differential.

In Indian markets, the most common form is cash-futures arbitrage. If Reliance Industries trades at Rs 2,450 on the NSE cash segment but the near-month futures contract trades at Rs 2,465, an arbitrageur buys in the cash market and simultaneously sells the futures contract, locking in a Rs 15 per share profit (minus transaction costs). This difference, called the "basis" or "spread," narrows to zero at Futures expiry.

Another common form in India is exchange arbitrage between NSE and BSE. While most liquid stocks trade at nearly identical prices on both exchanges, momentary discrepancies of Rs 0.50-2.00 can occur in less liquid names. High-frequency trading firms exploit these gaps within milliseconds using co-located servers at the exchange data centres.

Arbitrage mutual funds in India are popular for their tax efficiency. These funds maintain 65%+ equity exposure (qualifying for equity taxation) while actually earning near-debt returns through cash-futures arbitrage. Funds like HDFC Arbitrage Fund or Kotak Equity Arbitrage Fund typically deliver 6-7% annually with minimal volatility — making them attractive alternatives to liquid funds for short-term parking of money, especially for investors in the 30% tax bracket.

SEBI regulations require that Derivative positions have adequate margin. For cash-futures arbitrage, the combined margin requirement on the futures leg (typically 15-20% of contract value) is the primary capital cost. The annualised return from arbitrage depends on the basis spread, which widens during volatile markets and narrows during calm periods.