ARBITRAGE OPPORTUNITIES IN INDIAN DERIVATIVE MARKET

Abstract

Derivatives are financial contracts whose values are derived from the value of an underlying primary financial instrument, commodity or index, such as: interest rates, exchange rates, commodities, and equities. Derivatives include a wide assortment of financial contracts, including forwards, futures, swaps, and options. Market deregulation, growth in global trade, and continuing technological developments have revolutionized the financial marketplace during the past two decades. A by-product of this revolution is increased market volatility, which has led to a corresponding increase in demand for risk management products. Two portfolios with the same payoffs should be priced similarly if not, then there exists an arbitrage opportunity where the trader can make a profit, the trader can sell the higher priced portfolio and buy the cheaper portfolio. Arbitrage brings back prices of such portfolios to their fundamental price. According to Classical theories such arbitrage opportunities arise due to market inefficiencies and are taken care by the market consisting of rational investors and arbitrageurs. In reality, these inefficiencies/opportunities do persist from time to time - due to information asymmetry and various other risks associated with performing the arbitrage. One such arbitrage opportunity exists while trading one of the NSE's equity derivative product i.e. NIFTY50 Futures. The purpose of this project is to study the NIFTY 50 index to find out such opportunities in the NSE‟s Nifty 50 Index future derivative. In this project work the mispricing in the NIFTY50 Futures have been identified by calculating its theoretical value using cost of carry model and comparing it with its spot value for past 5 years. With the help of statistical tools in MS-Excel, the correlation in the Spot and future price has been established to empirically provide the evidence for existence of arbitrage opportunity. The methodology for pricing of future instruments is studied and reasons for mispricing have been identified. The net Annual return obtained by undertaking arbitrage trading is also estimated. the data is collected from NSE and RBI website and statistical tools pack in MS-excel have been used to carry out the calculations.