Arbitrage and hedging strategies using derivatives in India

Abstract

We studied three arbitrage strategies and tested them on Indian derivatives markets from November to April 2009. Mostly we used Nifty derivatives as these are most traded contracts. We tested these strategies for all possible transaction costs relevant for Indian derivatives market. The study brought up some interesting findings. As per the study, while the Indian derivative markets are efficient, however they do provide some arbitrage opportunities. Among option arbitrage strategies, Box spread arbitrage strategies tend to give more opportunities than the conversion/ reversal arbitrage strategies. As regards the Futures market strategies –price differential between cash and futures market, interviews with traders and arbitragers showed that most of the arbitrage play in India is concentrated on the largely traded future contracts such as Nifty and Reliance. Among the transaction costs, STT (Security Transaction Tax) forms the largest cost component and hence a king of spoilsport in arbitrage opportunities. This could be possibly one of the reasons why there was a resounding demand in the Union Budget 2009 to scrap STT.