Reverse Cash-and-Carry Arbitrage

Demystifying Reverse Cash-and-Carry Arbitrage: A Comprehensive Guide

Key Takeaways

1. Reverse cash-and-carry arbitrage involves a short position in an asset and a long futures position in the same asset to exploit pricing inefficiencies.
2. The strategy aims to capitalize on the difference between the asset's spot price and the futures price to generate riskless profits.
3. Backwardation, where futures trade at a discount to spot prices, is essential for a profitable reverse cash-and-carry arbitrage.

Understanding Reverse Cash-and-Carry Arbitrage

Reverse cash-and-carry arbitrage presents a strategy opposite to traditional cash-and-carry arbitrage. Here, the investor holds a short position in an asset while simultaneously taking a long position in its futures contract. At maturity, the investor accepts delivery of the asset against the futures contract, covering the short position. This strategy is profitable if the futures price is lower than the spot price of the asset, capitalizing on pricing discrepancies.

Example of Reverse Cash-and-Carry Arbitrage

Consider an asset trading at $104 with a one-month futures contract priced at $100 and carrying costs of $2. An arbitrageur initiates a short position in the asset at $104 and simultaneously buys the one-month futures contract at $100. Upon maturity, the investor accepts delivery of the asset, covering the short position, resulting in a riskless profit of $2.