1. VII: Futures
22: Arbitrage

2. Futures Hedge Speculate Arbitrage
use futures to reduce risk on an existing position
Speculate
use futures to take on risk in the hope of making a profit
Arbitrage
Use the difference between spot and futures prices to generate risk-free profit

3. Arbitrage
Shares of Discovery Café trade in the primary market (NYSE) and in the Champaign-Urbana Stock Exchange (CUSE).
DVC
$100
CUSE
CUSE
$1.50 brokerage
$1.50 brokerage

4. Arbitrage Price range on the CUSE Arbitrage-free price range Buy CUSE
& sell NYSE
Buy NYSE
& sell CUSE
$100
NYSE

5. Arbitrage Price range on gold futures Arbitrage-free price range
Buy futures
& sell spot
Buy spot
& sell futures
Low price
Spot gold
High price

6. Arbitrage Gold Futures Spot 1 year contract 1 c is 100 troy ounces
Margin is $1,800 and $1000 per contract
Spot
Gold is trading at $370/ounce

7. Arbitrage Price range on gold futures Arbitrage-free price range
Buy futures
& sell spot
Buy spot
& sell futures
$340
Spot gold
$370
$400
© Oltheten & Waspi 2012

8. Arbitrage: Buy spot; sell futures Buy spot at $370/ounce
Sell futures at $400/ ounce
Profit: $30/ounce (minus a few costs of carry)

9. Arbitrage October 2011 Buy 100 ounces gold @$370/oz
storage & insurance
Sell 1 October 08 gold $400/oz
Initial Margin
Borrow at 5% for 12 months
Initial Investment
October 2012
Deliver $400 contracted price
Margin returned
Repay loan
Principal
interest
Arbitrage Profit
© Oltheten & Waspi 2012

10. Arbitrage October 2011 Buy 100 ounces gold @$370/oz
storage & insurance
Sell 1 October 07 gold $X/oz
Initial Margin
Borrow at 5% for 12 months
Initial Investment
October 2012
Deliver gold at contracted price $X
Margin returned
Repay loan
Principal
interest
Arbitrage Profit
© Oltheten & Waspi 2012

11. Arbitrage Arbitrage-free price range Buy futures & sell spot Buy spot
& sell futures
$340
Spot gold
$370
© Oltheten & Waspi 2012

12. Arbitrage October 2011 Short Sell 100 ounces gold @$370/oz
borrowing fee
Buy 1 October 08 gold $340/oz
Initial Margin
Invest at 5% for 12 months
Initial Investment
October 2012
Take delivery of the $340 contracted price
Margin returned
Cash in investment
Principal
interest
Arbitrage Profit
© Oltheten & Waspi 2012

13. Arbitrage October 2011 Short Sell 100 ounces gold @$370/oz
borrowing fee
Buy 1 October 07 gold $X/oz
Initial Margin
Invest at 5% for 12 months
Initial Investment
October 2012
Take delivery of the $X contracted price
Margin returned
Cash in investment
Principal
interest
Arbitrage Profit
© Oltheten & Waspi 2012

14. Arbitrage Arbitrage-free price range Buy futures & sell spot Buy spot
& sell futures
Spot gold
$370
© Oltheten & Waspi 2012

15. Futures III