Reverse Cash and Carry Arbitrage Explained

Everyone wants to make a profit in the stock market but did you know that some smart traders make money without risk even when the market is stable? This is called Arbitrage Strategy. 

In this blog, we will understand in simple language what is Reverse Cash and Carry Arbitrage, how it works, and how to make a profit from it too without knowing the direction of the market. If you want to know what is cash and carry arbitrage and its reverse form, then this guide is for you.

What is Cash and Carry Arbitrage?

Cash and Carry Arbitrage is a trading strategy in which traders buy an asset (such as a stock or index) at the current price (spot price) and sell the same asset at a fixed price (futures price) in the futures market. It is profitable when the futures price is higher than the spot price, that is, when the market is in contango.

Let us understand with an example : Suppose the spot price of Stock A is ₹5,100 now, and the futures price after one month is ₹5,350.The trader buys Stock A at ₹5,100 and sells the futures at ₹5,350. Here the difference is ₹250. If the total expenses (like brokerage, funding cost etc.) are ₹100, then a net profit of ₹150 is left without any directional risk.

Step	Description
Spot Buy	Buying Stock A at ₹5,100
Futures Sell	Sell futures at ₹5,350 at the same time
Net Profit	₹250 – ₹100 = ₹150 (almost assured profit)

Cash carry arbitrage is used extensively by large investors, professional traders and arbitrage mutual funds, especially when such price gaps are present in the market and execution can be fast.

The Opposite Side: What is Reverse Cash and Carry Arbitrage?

Reverse Cash and Carry Arbitrage is a trading strategy in which the trader sells an asset in the spot market (short sell) and buys the same asset in the futures market (buy futures). This strategy is exactly the opposite of cash and carry arbitrage where first you buy and then sell.

It is beneficial when the market is in backwardation, that is, when the price of futures is lower than the spot. In such a situation, the trader sells at a higher price today and takes a contract to buy the same asset in the future at a lower price.

Let us understand with an example:

Suppose the current (spot) price of Stock B is ₹7,252, and the futures price is ₹6,800.

The trader shorts (borrows and sells) Stock B at ₹7,252 and buys its futures at ₹6,800. If the total expenses are ₹300 (loan cost, brokerage etc.), his potential profit will be: ₹7,252 – ₹6,800 – ₹300 = ₹152 per share.

Step	Description
Spot Sell	Short (Sell) Stock B at ₹7,252
Futures Buy	Buying Stock B Futures at ₹6,800
Net Profit	₹152 (after deducting all expenses)

There is profit in this (riskless arbitrage), provided the asset can be shorted and all transactions are completed on time and at a low cost. This strategy is mostly used by institutional investors and proprietary trading desks, as it requires a good understanding of both cash flow and borrowing.

Cash and Carry vs. Reverse Cash and Carry Arbitrage

Factor	Cash and Carry	Reverse Cash and Carry
What to do in Spot Market	Buy	Short Sell
What to do in Futures Market	Sell	Buy
When is it used	When futures price is higher than spot	When futures price is lower than spot
Objective	Lock in the premium	Benefit from the discount
Risk Level	Very Low	Low, but requires short selling facility
Who typically uses it	Mutual Funds, HNIs, Professional Traders	Proprietary Traders, Institutional Investors

Key Conditions for Profitable Reverse Arbitrage

• The market should be in backwardation : Reverse cash and carry arbitrage works only when the futures price is lower than the spot, i.e. the market is in backwardation. This situation usually arises when short-term demand is low or there is negative sentiment in the market. If the futures are not at a discount, then this strategy will not be profitable.

• Sufficient price gap between spot and futures price : A difference of just ₹5-₹10 will give negligible profit in real-time, especially when brokerage and taxes are also deducted. Trade only when there is a clear discount in both the prices – i.e. the gap is enough to leave a net profit even after deducting all expenses.
• Permission and access for short selling : The first requirement of reverse arbitrage is the facility of short selling. In India, this is possible only in the stocks of F&O segment. Apart from this, you should have experience and margin to trade in NSE F&O. This access is often limited for retail traders.
• Control of funding cost or interest rate : If you have borrowed capital for short selling or buying futures, the interest charged on it will affect your earnings. Low interest rate or 0% brokerage funding schemes can make this strategy even better.
• Calculate transaction costs in advance : Broker charges, STT, GST, transaction fees, and exchange charges can sometimes increase the cost by ₹100–₹200. If you do not add these in advance, your expected arbitrage profit will remain only on paper.
• Impact of cash flow and interest on free funds : Some traders partially free their funds by buying futures. If they receive interest on these free funds (like liquid funds or overnight lending), it adds an extra edge to the profit — especially in high volume trades.
• Liquidity and Execution Speed : The profit margins in reverse arbitrage are small, but the execution must be extremely fast and accurate. Low liquidity or delay can lead to a close spread. So focus on liquid stocks/indices like Nifty, Bank Nifty, Reliance or HDFC for this strategy.

Read Also: Arbitrage Trading in India – How Does it Work and Strategies

Benefits and Risks of Reverse Cash and Carry Arbitrage

Benefits of Reverse Cash and Carry Arbitrage

• Almost risk-free earnings : If all the conditions such as price gap, execution and cost control are met, this strategy is capable of delivering low-risk and assured returns.
• Protection from short-term volatility : This strategy is not based on directional trading, so even if the market goes up or down, the pre-locked profit is not affected.
• Capital Efficiency : Professional and HNI traders can open both the positions with limited capital which can improve their ROI. Sometimes this strategy proves to be more efficient than long-term investment.
• Predictable results : If the trade is held till expiry, the profit is almost fixed due to the convergence of futures and spot prices which reduces uncertainty to a great extent.

Risks of Reverse Cash and Carry Arbitrage

• Execution Risk : Both spot and futures trades need to be executed simultaneously and at the right price. A little slippage or delay can wipe out the entire profit margin.
• Margin Call and Position Risk : If the market suddenly becomes very volatile, a margin call may occur, especially if the position is large. This may lead to premature closure of the trade.
• Regulatory and Tax Complications : In India, STT (Securities Transaction Tax), tax on futures and limits on short selling can sometimes make this strategy less profitable.
• Limited access to short selling : Retail traders are often not allowed or facilitated to short sell in the spot market, making this strategy unviable for them.

Who Can Actually Use This Strategy?

• Institutional Investors : Large fund houses, insurance companies and FIIs use this strategy in large volumes as they have the capital, execution team and access to short-selling.
• Proprietary Trading Firms : These are professional traders who trade with their company’s money. They have real-time systems, arbitrage models and risk management that enables such a strategy to be put into practice.
• High Net Worth Individuals (HNIs) : Investors who have large trading capital and are active in the F&O segment can also take advantage of this strategy, provided they have access to short-selling.
• SEBI-registered arbitrage funds : Many arbitrage mutual funds in India monetize this strategy. If you cannot implement this strategy directly, you can get indirect benefit by investing in these funds.

Read Also: Arbitrage Mutual Funds – What are Arbitrage Funds India | Basics, Taxation & Benefits

Why is it difficult for retail investors?

While professional and institutional players can easily make profits from this strategy, there are many obstacles for retail investors. The biggest challenge is the limited facility of short selling, which is not usually available in the cash market. Apart from this, a relatively higher margin is required for futures trading. Also, if there is even a slight delay or slippage in trading, the profits of investors with limited capital can easily be wiped out. This is the reason why this strategy is not as simple in practice for retail traders as it seems.

Conclusion

Reverse Cash and Carry Arbitrage is a strategy that offers the opportunity to generate stable returns at low risk. While the profit potential is fixed, it requires precise execution, short selling flexibility, and cost control. This strategy is usually more useful for professional and institutional traders, but retail investors can also profit indirectly especially through arbitrage mutual funds. With the right information and planning, it can be an effective trading strategy. It is advised to consult a financial advisor before trading.