What is Cash and Carry Arbitrage

Last Updated: 29 Aug 2025

Before we get into cash and carry arbitrage, let us for a moment dwell on plain cash futures arbitrage. In a cash-futures arbitrage, you buy in the cash market and sell in the futures market. Intuitively, if the returns on the arbitrage are attractive, you go ahead and take a position in the cash-futures arbitrage. Now, cash and carry arbitrage goes one step ahead.

It is built on the premise of cash-futures arbitrage, but in reality, the cash and carry arbitrage also considers the cost of funds and other costs that impact the futures price vis-à-vis the spot price. In other words, the cash and carry arbitrage model also factors the cost of carrying into the arbitrage model. We will later understand in detail why this cash carry arbitrage approach to understanding arbitrage is so important.

CASH AND CARRY ARBITRAGE

Let us first understand, what exactly is meant by Cash and Carry Arbitrage? Cash and carry arbitrage is a financial arbitrage strategy that involves making the best of the anomalies in pricing or mispricing as it is called. This is the relation between an underlying asset and the financial derivative corresponding to it. Using the cash and carry arbitrage strategy, the trader gets a picture of the ideal cost of carrying for the contract, and based on the futures he can take a quick decision on whether or not the cash and carry arbitrage strategy would be profitable and meaningful. The cash and carry arbitrage trader uses this opportunity to generate profits via a correction in the mispricing or mean reversion as we know it.

Understanding the Structure of Cash and Carry Arbitrage

Cash and carry arbitrage is a trading strategy that seeks to benefit from the price gap between a real asset and its related derivative or futures contract. The goal is to lock in a profit by buying the asset in the spot market and simultaneously selling its futures equivalent. The edge this model offers over traditional cash-futures arbitrage lies in how it factors in the “cost of carry” to assess underpricing. Here, the trader assumes the cash position is funded via borrowing, while the short futures position is backed by pledging that same asset as collateral.

In practice, a trader will only execute this strategy after spotting a genuinely rewarding opportunity, specifically, when the futures price trades at a hefty premium over the expected spot price (spot price plus carrying costs). In equity futures, this carry cost is largely just interest, as settlement is in cash. But in commodity markets where delivery is possible, the carrying cost also includes expenses like insurance, storage, and demurrage, alongside the interest or opportunity cost of funds.

Here’s how it works with commodities: the trader buys and holds the commodity until the futures contract’s expiry or delivery date. At that point, they deliver the asset against the contract, securing a risk-free gain.

The profit is simply the futures sale price minus the purchase price and total carrying costs such as insurance, storage, transport, and the notional cost of capital. By selling the futures contract at the outset, the trader fixes the final selling price and locks in the spread. This way, no matter how the spot price moves by expiry, the arbitrage profit, after carry costs, is guaranteed.

Live example of cash and carry arbitrage

Let us take an instance where the underlying asset trades at Rs.101 in the market, with a total of Rs.3 worth of carrying costs associated with it. Fortunately for the trader, there is a futures contract priced at Rs.108. Here is what the actual cash and carry arbitrage transaction would look like.

The investor purchases the commodity at Rs.101, an effective long position. The arbitrageur also simultaneously sells the futures contract at $108. By selling the futures contract, the investor has effectively locked in the sale price of Rs.108. The investor will hold the underlying until the delivery date of the futures and then delivers it on the date against the futures contract and pocket the arbitrage profit. Here is what profits would look like.

Since there is a cost of carrying of Rs.3 on the transaction, his effective cost is Rs.104 (the cost price plus cost of carrying). However, we know that due to selling the futures, the sale price is already locked in at Rs.108, and hence there is no uncertainty here at all. The investor makes the best of this cash and carry arbitrage and realizes a profit of Rs.4 (108-104) by exploiting the mispricing to his advantage.

The only risk in cash and carry arbitrage is that cost of carrying can be fluid at times.

How Does Cash-and-Carry Arbitrage Work?

1.Identify the Arbitrage Opportunity

Compare the spot price of the asset with its futures price. When the futures price exceeds the spot price by more than the cost of carry, a potential pricing inefficiency exists, which is the opening for a cash-and-carry arbitrage trade.

2.Buy the Asset in the Spot Market

Purchase (go long) the underlying commodity, stock index, or cryptocurrency at the current spot price.

3.Short the Matching Futures Contract

Simultaneously sell (go short) an equivalent amount of the futures contract that matures on a chosen future date.

4.Finance and Store the Asset

Hold the asset until the futures contract expires. Carrying costs include financing (interest on borrowed cash), storage, insurance, and any opportunity cost.

5.Deliver or Net-settle at Expiry

On the contract’s settlement date, deliver the asset against the futures short (or offset both positions). The gain equals: Futures price−(Spot price+Cost of carry).

This step-by-step process is the essence of what is cash and carry arbitrage and underpins what is cash and carry trade strategies widely used by commodity traders, hedge funds, and crypto-basis desks.

Key Components of Cash-and-Carry Arbitrage

Component	Role in the Cash-and-Carry Model
Spot price	The entry cost to acquire the asset immediately.
Futures price	Exit price locked in today for future sale.
Cost of carry	Sum of financing rates, storage, insurance, and convenience yield.
Time to maturity	Longer durations increase cumulative carry costs.
Asset liquidity	Deep markets lower bid-ask spreads and slippage.
Margin requirements	Capital is tied up to maintain the short futures position.

These inputs form what is cash and carry model pricing:

F0 = S0 × e^( (r + u − y) T )

Where –

• F0 is the theoretical fair futures price
• S0 is the spot price
• r is the risk-free rate
• u represents storage costs
• y is the convenience yield, and
• T is the time to maturity (in years)

When Is Cash-and-Carry Arbitrage Profitable?

Cash-and-carry arbitrage becomes attractive when:

• The quoted futures price is significantly higher than (Spot price + Cost of carry).
• Put differently, the basis (Futures − Spot) is large and positive, exceeding all carry expenses.
• Markets are in contango, meaning futures trade above spot because of expectations or high financing costs.
• There is enough market depth to execute large spot purchases and futures shorts without moving prices.

When these conditions align, the trader locks in a risk-free spread as long as both markets function smoothly.

Risks Involved in Cash-and-Carry Arbitrage

• Basis risk – The spot-futures spread can shrink or invert before expiry, eroding the locked-in profit and triggering stop-outs.
• Funding risk – Sudden spikes in short-term interest rates lift the cost of carry and may turn the trade unprofitable.
• Margin risk – An adverse move in the futures price forces additional variation or maintenance margin, tying up capital or causing a liquidation at a loss.
• Liquidity risk – Thin markets or wide bid-ask spreads make it hard to execute the spot purchase or roll out of the futures leg without slippage.
• Counterparty risk – Default by the broker, clearing house, or storage custodian jeopardises one side of the trade.
• Storage and quality risk – For physical commodities, unexpected warehousing fees, spoilage, or delivery-grade mismatches add unplanned costs.
• Regulatory risk – New position limits, higher margin requirements, or short-selling bans can force early unwinds.
• Operational risk – Settlement errors, incorrect contract sizing, or misaligned expiry dates create P&L mismatches.
• Tax and settlement-currency risk – Differing tax treatments or a sharp FX swing between purchase and settlement erode returns.

Advantages of Using Cash-and-Carry Arbitrage

• Exploits pricing inefficiency – Captures a near-risk-free spread when futures trade above spot plus carry.
• Market-neutral exposure – Long spot and short futures offset outright price moves, reducing directional risk.
• Predictable profit – Both entry (spot buy) and exit (futures short) prices are fixed, allowing upfront P&L projection.
• Diversifies returns – Arbitrage opportunity performance is largely uncorrelated with traditional long-only equity or commodity beta.
• Capital efficiency – Margin on the short futures leg can be lower than buying the asset outright, boosting return on equity.
• Supports market efficiency – Arbitrage pressures force spot and futures prices back to theoretical parity, improving price discovery for all participants.
• Scalability in liquid markets – High-volume venues for gold, crude oil, equity indices, or bitcoin futures allow sizable trades without moving the market.
• Flexible horizon – Traders can choose contract maturities that match their funding costs and storage capacity.

Reverse Cash and Carry Arbitrage

Reverse cash-and-carry arbitrage is a market-neutral trading approach that involves taking a short position in the asset while holding a long position in its futures contract. Think of it as the mirror image of the traditional cash and carry strategy. The aim here is to take advantage of price gaps between the asset’s spot price and its related futures price to lock in risk-free profits. This strategy is typically used by traders who already hold the shares in their portfolio, and they turn to reverse arbitrage when the cash-futures spread turns negative. Such opportunities are rare and tend to emerge only occasionally.

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. You can look at this strategy as the exact opposite of the traditional cash and carry arbitrage. The goal of this reverse cash and carry arbitrage is to exploit pricing inefficiencies between that asset’s cash, or spot, price, and the corresponding future’s price to generate riskless profits. Normally, the reverse cash and carry arbitrage is done by traders who are owning the shares in their portfolio and when the cash-futures spread becomes negative, you indulge in reverse arbitrage. These are not common and arise infrequently.

COST OF CARRYING

The cost of carrying summarizes the relationship between the futures price and the spot price. In others words, the spot price plus the cost carry is the expected spot price. It is the cost of carrying or holding a position from the date of entering into the transaction up to the date of maturity. It measures the storage cost plus interest that is paid to finance the asset less the income earned on the asset.

Frequently Asked Questions

How do you calculate cash and carry arbitrage?

Assume the following data for your own understanding. Assume that the spot price is Rs.1500 and the price of the monthly futures to be sold is Rs.1520. If you assume an annualized implied cost of carry of 8%, then the fair price measured as the expected spot price at the time of futures expiration would be Rs.1505.70. Here the effective profit after considering cost of carry is Rs.15.30 and this has to be multiplied by the lot size to get the actual profit earned per lot from the cash and carry arbitrage. Remember that this is the assured profit for the cash and carry arbitrageur irrespective of whether the price of the commodity in the market shoots up or falls sharply.

What is cash and carry trade?

A cash-and-carry trade is a trading strategy that an investor can utilize in order to take advantage of market pricing discrepancies. It usually entails taking a long position in a security or commodity while simultaneously selling the associated futures contract. IT is normally done when the futures is more than the expected spot price as per the cost of carry model.

What is cash future arbitrage?

Cash futures arbitrage is all about Buying in cash and selling in futures. This is normally undertaken when the futures is at a substantial premium to the spot price.