Cash-and-Carry Arbitrage: Strategy and Example

Cash-and-carry arbitrage is a market-neutral strategy that exploits pricing differences between the spot (cash) market and the futures market for the same underlying asset. The arbitrageur buys (goes long) the physical asset or spot position, shorts the corresponding futures contract, and “carries” the asset until the futures contract expires — delivering the asset to fulfill the short futures position. If the futures price is sufficiently high relative to the spot price plus carrying costs, the trade locks in a (theoretically) riskless profit.

How it works — key mechanics

• Buy the asset at the current spot price (S).
• Simultaneously sell (short) the futures contract at price (F).
• Hold the asset until futures expiry and deliver it against the short futures position.
• Profit occurs if F exceeds S plus all carrying costs (storage, insurance, financing, and transaction costs).

Simple profit relation:
Arbitrage profit ≈ Futures price − Spot price − Carrying costs

Cost-of-carry pricing intuition:
Futures ≈ Spot + Cost of carry (financing + storage − convenience yield). In efficient markets, this relationship generally holds, reducing persistent arbitrage opportunities.

Numerical example

• Spot price: $100
• One-month futures price: $104
• Monthly carrying costs (storage, insurance, financing): $3

Trade:
1. Buy the asset for $100.
2. Short the one‑month futures at $104.
3. At expiry, deliver the asset against the short futures.

Outcome:
Profit = 104 − 100 − 3 = $1 (ignoring transaction costs and taxes).

When opportunities arise

• More likely in less efficient or less liquid markets where spreads and mispricing occur.
• Easier to implement for financial underlyings (e.g., stock-index futures) because carrying costs are mainly financing and there are no physical storage/insurance needs.
• Harder in highly liquid, well‑arbitraged markets where many participants quickly eliminate mispricings.

Risks and practical limitations

• Carrying costs can increase (rising interest rates, higher storage/insurance), eroding or reversing profits.
• Margin calls on the short futures position can require additional cash and cause liquidity strain.
• Transaction costs, bid–ask spreads, and financing/borrowing costs can eliminate thin arbitrage margins.
• Delivery and settlement mechanics vary: some futures are cash-settled (no physical delivery), which changes execution details and may introduce basis risk.
• Execution risk: prices may move between trade entry and completion if one side cannot be executed simultaneously.
• Tax, regulatory constraints, and availability of borrowable assets or suitable futures contracts can limit practical implementation.

Practical considerations for traders

• Ensure liquidity on both spot and futures sides to enter and exit at favorable prices.
• Accurately estimate all carrying costs and transaction fees before initiating a trade.
• Monitor margin requirements and have sufficient collateral to meet potential calls.
• Consider basis risk (the risk that spot and futures prices converge differently than expected) and differences in contract specifications.
• Recognize that returns per trade are often small; the strategy may require scale and low costs to be attractive.

Conclusion

Cash-and-carry arbitrage aims to capture risk‑free profits from a futures premium over the spot price after accounting for carrying costs. While conceptually straightforward, successful implementation requires careful accounting for financing, storage, transaction costs, liquidity, and settlement mechanics. In efficient, liquid markets these opportunities are rare and typically narrow, while less active markets may offer occasional mispricings worth exploiting.