Arbitrage - Calendar Spread and Cash & Carry really work?

Discussion in 'Trading' started by heispark, Nov 13, 2019.

  1. heispark


    In theory it sounds nice but if it's that easy, anyone could become millionaire. In practical trading, does this arbitrage really work with minimum risk? What is the risk? And what can be the best for this trade? I am looking /NG and FX currencies for this opportunity. :rolleyes:
    Last edited: Nov 13, 2019
  2. Wheezooo


    In some products very well. Think GC or any product where storage is simple, and the product remains identical over time.

    Now NG,.... boy oh boy... dat be a horse of a totally different color. Year over year -after 3-4 years - I'd say yes... Month to month... <snickers>.
    heispark likes this.
  3. heispark


    Between Calendar Spread (futures-futures) and Cash & Carry (spot-futures), which one should be safer? Considering 'widow maker' spread of /NG (I heard that in the In, I guess sometimes calendar spread can unexpectedly widen between front and later months and therefore make this calendar spread strategy can fail. Also, later month contract usually has thin liquidity. Is Cash & Carry safer than Calendar Spread? For example, at this time of wring, EURUSD (forex) is 1.10105 and 6EZ9 (futures) is 1.10335 (spread between them is 23 pips). If I sell 1 contract of 6EZ9 and buy 1.25 lot (125000 EUR) of EURUSD at the same time right now, can I lock this profit (bid/ask spread, slippage and minor tracking errors not considered for convenience) as 6EZ9 goes to expiration? (forex swap is also not considered in this calculation for convenience). Does this work? Do I have anything missing? Is there any hidden risk?

    Futures Prices Converge Upon Spot Prices
    Last edited: Nov 13, 2019
  4. Sig


    On the forex side the answer to your question is absolutely, you're missing the fact that the futures/spot spread exactly reflects the delta in interest rates between the two futures. For your proposed trade, you're forgetting that the 1.25 lot of EURUSD you buy is going to charge you a daily roll rate which over the time you hold this position will at least equal the amount you make on the future/spot spread (actually you'll lose money because the roll rate at any spot "broker" is way higher than the inter-bank interest rate).
    drm7 and heispark like this.
  5. heispark


    Currency Futures Arbitrage Basics

    Because of interest rate differentials, currency futures tend to sell at a premium or at a discount, depending on how wide the interest rate differential is between the currencies of the two countries involved.

    If the currency futures contract is for the Pound Sterling quoted against the U.S. Dollar, for example, and the pertinent interest rate in the UK is at two percent, while U.S. rates are at only one percent, then Sterling would trade at a forward discount relative to the spot rate.

    This is due to the carrying cost differential of one percent since you would be better off buying Sterling spot and holding it until the value date than buying it forward against the Dollar.

    The above figures will now be used to illustrate how a six-month futures contract for Sterling can be arbitraged against the spot market. First of all, the following market and contract parameters will be used:

    The GBP/USD spot rate is trading at 1.2500.
    The 6-month futures contract for GBP/USD is trading at 1.2400.
    The 6-month interest rate on GBP is two percent.
    The 6-month interest rate on USD is one percent.
    The contract size is 1,000 units of currency.
    The futures contract can be converted at the option of the seller of the contract into physical currency at the specified exchange rate when the futures contract matures in six months. The buyer of the 6-month GBP/USD futures contract would receive £1,000 and deliver $1,240 at the contract’s maturity in six months’ time.

    The arbitrageur could then sell Sterling forward against the U.S. Dollar against the long futures contract. Alternatively, they could deposit £990.00 for six months at two percent. On the U.S. Dollar side, the trader would borrow $1,237 or the amount £990.00 would buy at the spot rate of 1.2500. A synthetic future would then be created converting £1,000 into $1,237 in six months’ time with a current cost of $1,237.

    These numbers would indicate to an arbitrageur that the futures contract is trading slightly higher than it should be by three dollars per thousand. The arbitrage can then be established with the arbitrageur selling the futures contract for 1.2400 and buying spot with a net profit of $3.00 per thousand at the futures contract maturity. While $3.00 per thousand does not seem like a large profit on the trade, when the transaction is done in a large amount like $100,000,000, then the net profit would be a much more respectable $30,000.
  6. Sig


    That's a good textbook definition. It's not something that really exists in the wild because it's so easy to arb which eliminates the opportunity. If you are interest in this at small scale you might look at finding banks offering teaser high CD rates in your currency you're parking the spot long position in and do something like a box spread sale to finance your borrowing currency at as close to the wholesale rate as you can get, at which point you might be able to eek out a few dollars. The whole exercise might be fun though, just for the experience of it.
    Alexpung and heispark like this.
  7. heispark


    At this time of writing, Natural Gas NGZ9 is $2.595 and NFG0 is $2.686. Will they converge each other as NGZ9's expiration approaches?

    Last edited: Nov 13, 2019