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Market Watch | An arbitrage opportunity

business Updated: Dec 04, 2007 22:59 IST
Udayan Mukherjee

There are two ways to participate in a retail-fuelled momentum market. The aggressive way is to buy stock futures in momentum stocks and hope the party lasts long enough. The conservative way is to milk the substantial arbitrage opportunities that arise out of the general appetite for stock futures. Something which a lot of institutional investors do actively. This is like the good old badla: in times of heightened speculative activity like this, badla rates would shoot up to 20-25 per cent. Virtually risk-free returns. Exactly what you can capture today by playing between the cash and futures market.

The thing to monitor is how much premium the futures of any stock is trading at above the cash market price. If the premium is 1 per cent or more, it opens up a good arbitrage opportunity. For the uninitiated, it is simple: just buy the stock in the cash market and sell the stock futures, hold it till expiry and unwind the trade towards the end of the series, locking the difference in. 1 per cent a month is 12 per cent annualised, so even a 1.25 per cent futures premium, also referred to as the cost of carry, generates a 15 per cent annulaised return for you. For example, this month, liquid stocks like Reliance Industries Ltd, Reliance Petroleum, Ashok Leyland, Andhra bank, Chennai Petro are giving you arbitrage returns of 15-18 per cent annualised. It is almost risk free unless the stock goes ballistic towards the end of the series. These returns compare very favourably to any fixed income product in the market.

This may seem a bit complicated for the average investor, though it is not. One could simply call his broker and leave instructions, brokers do these things for a living. Or even easier, there are a clutch of arbitrage funds from reputed mutual fund houses which do exactly the same thing. Stanchart has a Rs 1,300 crore arbitrage fund, Pru ICICI, State Bank of India (SBI), JM all run fairly large arbitrage funds running into hundreds of crores.

Next time, before you lock your money into a fixed deposit or a fixed income fund, do check out these opportunities. You can make your money work in the stock market even without taking the attendant risks.

Udayan Mukherjee, Executive Editor, CNBC-TV18