A stock future usually trades at a small premium to the share price, reflecting the cost of carrying the position until expiry. Cash and carry arbitrage is the trade that captures that premium: buy the shares, sell the future, and wait for the two prices to converge at expiry.
This article explains why the gap exists, works through an example, explains why the returns are modest, sets out the costs and risks that make it less simple than it looks, and shows how arbitrage mutual funds use the same idea.
Why futures trade above the share price
A futures contract is an agreement to buy or sell at a set price on a future date. Someone who buys the future instead of the shares keeps their cash in the meantime, which could earn interest. So the future is normally priced above the share price by roughly the interest cost of holding the shares until expiry, less any dividends expected before then.
This premium is called the basis. As expiry approaches, there is less time left to carry, so the basis shrinks. On expiry day, the futures price and the share price converge, because the contract settles against the share price.
The basis is not fixed. It changes with interest rates, dividend expectations, demand for leverage, and market sentiment. In very bullish periods it can widen; in stressed periods it can shrink or even turn negative.
The trade, with a worked example
Illustrative figures. A share trades at 1,000. Its near-month future, expiring in 30 days, trades at 1,005, a basis of 5, or 0.5 percent.
The trade: buy the shares at 1,000 and sell the future at 1,005, in equal quantity. With a hypothetical lot of 500 shares, that is 5 lakh of shares bought and one lot of the future sold.
At expiry, the prices converge. Suppose the share ends at 1,100. The shares gained 100 each; the short future lost 95 (from 1,005 to 1,100). Net: 5 per share. Suppose instead it ends at 900. The shares lost 100; the future gained 105. Net: again 5 per share.
Whatever happens to the price, the gross result is the basis captured at entry: 5 per share, or 2,500 on 500 shares, before costs. Over 30 days, 0.5 percent is roughly 6.3 percent annualised, before charges and taxes.
That is the appeal: a return that does not depend on the market's direction. It is also why the return is modest. The basis reflects interest rates, so the trade earns something similar to a short-term interest rate, not more. When the basis is unusually wide, it usually reflects strong demand for leveraged long positions, and it tends to be competed away quickly by large participants with lower costs.
Costs that eat the spread
Because the gross return is small, costs matter enormously.
Brokerage and statutory charges on four transactions: buying the shares, selling the future, and closing both (or settling at expiry). Securities transaction tax, exchange charges and stamp duty apply to each leg in different ways.
Bid-ask spreads on both the shares and the future. Entering at the far side of each spread can cost a meaningful part of the basis.
Capital tied up. The shares must be paid for in full, and the short future needs margin on top. The return on the total capital used is lower than the basis alone suggests.
Tax. Gains and losses on the shares and the futures can be treated differently for tax purposes. Check the current treatment before assuming the net figure is what you keep.
For an individual paying retail charges, a basis that looks attractive on screen can shrink to very little after everything is counted.
The practical risks
The trade is often described as risk-free. It is not.
Mark-to-market on the future. If the share price rises sharply, the short future shows losses that must be paid in cash daily, even though the shares have gained. You need spare cash to meet these.
Execution risk. If one leg fills and the other does not, or fills at a worse price, the locked-in spread changes.
Dividend surprises. If a dividend is larger or earlier than priced into the future, the economics change.
Settlement. Stock futures are physically settled. Holding to expiry means the shares you hold are delivered against the short future, which completes the trade cleanly, but you need to understand the process and margins in the expiry week.
Corporate actions and bans. Splits, bonuses and F&O ban periods can complicate or restrict the position.
The reverse trade is harder. When the future trades below the share price, the opposite trade requires selling shares you do not own for the whole period, which retail investors generally cannot do outside the intraday window.
Arbitrage funds: the same idea, packaged
Arbitrage mutual funds run this trade at scale across many stocks, rolling positions each month and holding cash or short-term debt for the remainder.
What investors get: returns that broadly track short-term interest rates, with low volatility, through a single investment, without managing margins or settlement.
What to know: returns vary with the basis available, which can shrink in quiet or stressed markets. The fund has its own expense ratio. Exit loads may apply for short holding periods. Tax treatment depends on the fund's classification and current rules, so check it rather than assume.
For most individuals wanting this kind of return, a low-cost arbitrage fund or another short-term option is far simpler than running the trade themselves.
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See share and futures prices side by side, with margins and charges shown before any order. Free to open
Figures are illustrations; lot sizes, margins, charges and taxation are set by the exchanges, SEBI and tax law and change from time to time. This is educational material, not advice, and no position or fund is recommended. We run no tips group and no signal service, we manage nobody's money, and no return is promised. Derivatives can lose more than the amount blocked against them.
Disclosure: the account-opening link on this page is under Atul Shrivastava's Zerodha Authorised Person registration (NSE AP Reg: AP2516003481; Zerodha Broking Ltd. SEBI Reg: INZ000031633) and earns a revenue share. TheFinBaba is not a SEBI-registered Investment Adviser — this content is educational, not investment advice.
Frequently Asked Questions
What is cash and carry arbitrage?
Buying shares and selling the same stock's future, which usually trades at a premium, then holding until expiry when the two prices converge, capturing that premium.
How much does cash and carry arbitrage earn?
Roughly a short-term interest rate before costs, because the futures premium reflects the cost of carry. Retail charges and spreads can reduce it substantially.
Is arbitrage between cash and futures risk-free?
No. It involves mark-to-market cash needs, execution risk, dividend surprises, settlement procedures, and costs that can erase a small spread.
Why do futures trade above the share price?
Because buying the future instead of the shares keeps cash free to earn interest until expiry. The premium approximates that interest, less expected dividends.
What are arbitrage funds?
Mutual funds that run this trade across many stocks, aiming for low-volatility returns broadly in line with short-term interest rates.
Related Reading
- Why the quoted gap costs money
- Time as a cost in derivatives
- The basis in more detail
- Daily settlement on futures
- Simpler homes for idle cash
- When new F&O positions are barred
Disclaimer: TheFinBaba provides educational content only - this is not investment advice. Trading involves risk of loss.
