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The August SBI Futures contract, which closed at Rs 1,603.60 at the NSE on Friday, presents a good short-term investment opportunity. The underlying SBI stock closed at Rs 1,584.25 in the cash market last week. At these levels, the August contract has been priced at around a 12 per cent annual rate of interest.

Investors who can borrow money at less than 12 per cent can make arbitrage profits through the following strategy:

Sell August SBI futures at 1603.60;

Borrow Rs 1,584.25 for the period up to the maturity of the August contract (August 30) at a rate of interest which should be lower than 12 per cent. Assuming a borrowing rate of 10 per cent per annum, the following strategy can be adopted:

Buy the underlying stock in the cash market;

For the period up to August 30, the borrowing would have accumulated to around Rs 1,600;

At the maturity of the futures, deliver the stock under the contract. Get the proceeds of Rs 1,603.60 and pay off the borrowings (with interest) of Rs 1,600;

This results in a net profit of Rs 3.60 per contract.

This strategy appears to be possible because of the relatively high rate of interest implicit in the futures pricing. With some signals of market interest rates softening, investors with a high risk appetite, good financial resources and who can borrow at competitive rates of interest can possibly implement the above strategy.

The primary risk in this trading strategy will be on account of the market moving against the futures position. Under that scenario, investors may have to put up additional margins under the marking-to-market system. Therefore, the above strategy would be appropriate only for those investors who have a high risk appetite and who can put up the necessary margins – both at the initial stage when initiating the short futures position and on an on-going basis. The initial margin on the futures works out to around 13 per cent of the contract value.

A similar arbitrage opportunity also appears to be available with respect to the September futures contract on the SBI stock. This contract has been priced at around 11 per cent rate of interest.

T.B. Kapali

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August SBI Futures: Sell

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