
Reverse Cash-and-Carry Arbitrage
Reverse cash-and-carry arbitrage is a market-neutral strategy combining a short position in an asset and a long futures position in that same asset. For a reverse cash-and-carry arbitrage, the arbitrageur holds a short position in the asset, commonly a stock or commodity, and a long position in that asset's futures contract. Reverse cash-and-carry arbitrage is a market-neutral strategy combining a short position in an asset and a long futures position in that same asset. Reverse cash-and-carry arbitrage is a market-neutral strategy combining a short position in an asset and a long futures position in that same asset. Reverse cash-and-carry arbitrage seeks to exploit pricing inefficiencies between that asset's cash price and the corresponding futures price to generate riskless profits.

What Is a Reverse Cash-and-Carry Arbitrage?
Reverse cash-and-carry arbitrage is a market-neutral strategy combining a short position in an asset and a long futures position in that same asset. Its goal is to exploit pricing inefficiencies between that asset's cash, or spot, price and the corresponding future's price to generate riskless profits.



Understanding Reverse Cash-and-Carry Arbitrage
As its name suggests, reverse cash-and-carry arbitrage is the mirror image of a regular cash-and-carry arbitrage. In the latter, the arbitrageur carries the asset until the expiration date of the futures contract, at which point the asset will be delivered against the futures contract.
For a reverse cash-and-carry arbitrage, the arbitrageur holds a short position in the asset, commonly a stock or commodity, and a long position in that asset's futures contract.
At maturity, the arbitrageur accepts delivery of the asset against the futures contract, which is used to cover the short position. This strategy is only viable if the futures price is lower than the spot price of the asset. That is, the proceeds from the short sale should exceed the price of the futures contract and the costs associated with carrying the short position in the asset.
A reverse cash-and-carry arbitrage strategy is only worthwhile if the futures price is cheap relative to the spot price of the asset. This is a condition known as backwardation, where futures contracts with later expiration dates, also known as back month contracts, trade at a discount to the spot price. The arbitrageur is betting that this condition, which is abnormal, will revert back to form, thus creating the environment for a riskless profit.
Example of Cash-and-Carry Arbitrage
Consider the following example of a reverse cash-and-carry arbitrage. Assume an asset currently trades at $104, while the one-month futures contract is priced at $100. In addition, monthly carrying costs on the short position (for example, dividends are payable by the short seller) amount to $2. In this case, the arbitrageur would initiate a short position in the asset at $104, and simultaneously buy the one-month futures contract at $100. Upon maturity of the futures contract, the trader accepts delivery of the asset and uses it to cover the short position in the asset, thereby ensuring an arbitrage, or riskless, profit of $2 ($104 - $100 - $2).
The term riskless is not completely accurate as risk still exists, such as an increase in carrying costs, or the brokerage firm raising its margin rates. However, the risk of any market movement, which is the major component in any regular long or short trade, is mitigated by the fact that once the trade is set in motion, the next step is the delivery of the asset against the futures contract. There is no need to access either side of the trade in the open market at expiration.
Related terms:
Arbitrage-Free Valuation
Arbitrage-free valuation is the theoretical price of an asset based on the underlying real performance of the asset. read more
Arbitrageur
An arbitrageur is an investor who tries to profit from price inefficiencies in a market by making two simultaneous offsetting trades. read more
Back Months
In the commodity futures markets, the term “back months” refers to the futures contracts whose delivery dates are relatively far in the future. read more
Backwardation
Backwardation is when futures prices are below the expected spot price, and therefore rise to meet that higher spot price. read more
Carrying Costs
Carrying costs, also known as holding costs and inventory carrying costs, are the costs a business pays for holding inventory in stock. read more
Cash-and-Carry-Arbitrage
Cash-and-carry-arbitrage is the simultaneous purchase of an asset and selling short futures on that asset to profit from pricing inefficiencies. read more
Cash-and-Carry Trade
A cash-and-carry trade is an arbitrage strategy that exploits the mispricing between the underlying asset and its corresponding derivative. read more
Commodity
A commodity is a basic good used in commerce that is interchangeable with other goods of the same type. read more
Dividend
A dividend is the distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors. read more
Expiration Date (Derivatives)
The expiration date of a derivative is the last day that an options or futures contract is valid. read more