DefinitionĀ§
Cash-and-Carry Arbitrage refers to a trading strategy that involves buying an asset in the spot market and simultaneously selling it in the futures market when the futures price is theoretically overpriced compared to the spot price. The investor profits by holding the asset (carrying) until the futures contract expires, thereby āarbitragingā the price difference between these two markets.
| Cash-and-Carry Arbitrage | Basis Trading |
|---|---|
| Involves buying in the spot market and selling in futures | Involves taking advantage of price differentials between different contracts |
| Aims to exploit theoretical pricing discrepancies | Aims to exploit basis (spread between spot and futures prices) |
| Can incur carrying costs (storage, insurance) | Usually focuses on the delivery month of futures contracts |
| Primarily risk-neutral, though not without risks associated with holding assets | Generally entails some market exposure |
ExamplesĀ§
Imagine you purchase 100 ounces of gold in the spot market for $1,800 each while the futures price for gold to be delivered in three months is $1,850. You would then short (sell) the futures contract while holding the physical gold. By the time the contract expires, you deliver the gold, receiving $1,850 per ounceāja-ching! š¤
Related TermsĀ§
- Spot Market: The market where financial instruments are traded for immediate delivery.
- Futures Market: A market where participants buy and sell contracts for the future delivery of assets.
- Arbitrage: The practice of taking advantage of price differences in different markets to earn a profit.
DiagramĀ§
š¤” Humorous InsightsĀ§
- A wise trader once said, āArbitrage is the financial worldās favorite form of ākeeping up with the Jonesesāāyou spot their new ride and make out like a bandit while they still owe the bank!ā
- Fun Fact: The term arbitrage is derived from the Latin word arbitrari meaning āto judgeāābecause sometimes you need to be the judge, jury, and executioner of your portfolio!
Frequently Asked QuestionsĀ§
Q: Is there a guaranteed profit with cash-and-carry arbitrage?
A: āSure, kind of like how youāre guaranteed to find a parking spot if you arrive at the mall at 4 AMā¦in considerably less than ideal conditions.ā While cash-and-carry arbitrage theoretically should yield a risk-free profit, actual profits are impacted by carrying costs, fees, and price behavior differentials.
Q: Can I perform this strategy with any asset?
A: āIf your asset has a future market, you can give it a whirl! Just be sure to check if you have enough storage space for all that pineapple pizza you stockpiled.ā
References & Further ReadingĀ§
- Investopedia: Cash-and-Carry Arbitrage
- āOptions, Futures, and Other Derivativesā by John C. Hull
- āTrading and Exchanges: Market Microstructure for Practitionersā by Larry Harris
Test Your Knowledge: Cash-and-Carry Arbitrage QuizĀ§
Thank you for diving into the world of Cash-and-Carry Arbitrage! Remember, if you are in finance for the thrills, you might just find yourself amusingly off the deep end. Have fun trading!
