Dr Lal Pathlabs Ltd offers reverse arbitrage opportunity
What is Arbitrage?
Arbitrage strategy is the simultaneous buying and selling of shares in different markets in order to profit from the mispricing opportunity available between the futures and cash prices of the same underlying. One can buy or sell stocks in spot and assume opposite position in futures of the same stock to capture the difference between both prices. For this, the difference between spot and futures prices has to be reasonably high so that one can not only cover the transaction costs but also earn profit. Towards expiry, prices of spot and futures converge and unwinding can be done at the same price. Hence, the initial difference will be locked in at the time of initiating the whole transaction. This difference yields risk-free return since it will be independent of the price movement.
What is Reverse Arbitrage?
Whenever futures are trading at a substantial discount to spot, a reverse arbitrage opportunity arises. Minimum one lot of the underlying future is bought and the delivery of the same number of shares is sold in cash to lock in the price difference.
Currently, Dr Lal Pathlabs September future is trading at a discount of more than Rs 118/share while no dividend is expected in the current month. This discount provides an opportunity for reverse arbitrage. Currently, this opportunity accounts for (118/2380) = 496 bps. We can lock in the difference of 496 bps at current prices. This will result in risk-free profit of Rs 118/share excluding brokerage and transaction cost.
How to execute:
One can benefit from selling 600 shares of Dr Lal Pathlabs from demat holding and simultaneously buy one lot of September futures. During settlement, one should reverse the positions to capture the prevailing price difference.
Note: One needs to consider the cost associated while executing the strategy.
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