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NISM Certifications · NISM-Series-VIII: Equity Derivatives · Introduction to Forwards and Futures

Spot of a stock is Rs 800. A 2-month futures is quoted at Rs 816. With simple cost of carry (no dividends), the implied annual financing rate is 12%. A 1-month futures on the same stock is fairly priced at Rs 808. A trader finds the 2-month futures actually trading at Rs 824. Which action captures an arbitrage?

Fair value of the 2-month futures is Rs 816, but it trades at Rs 824, so it is overpriced. The arbitrageur buys the stock in the spot market and sells the futures, locking in about Rs 8 per share (cash-and-carry).

  1. ABuy the stock at spot and sell the 2-month futuresCorrect
  2. BSell the stock and buy the 2-month futures
  3. CBuy the 2-month futures and sell the 1-month futures
  4. DDo nothing as prices are fair

Explanation

Fair 2-month value = 800 × (1 + 0.12×2/12) = 816. Market at 824 is overpriced, so do cash-and-carry: buy spot, sell futures, locking Rs 8 riskless profit. The reverse would lose money.

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