Who are arbitrageurs?

A derivative refers to a financial product whose value is derived from another. A derivative is always created with reference to the other product, also called the underlying.

If the price of the underlying is Rs.100 and the futures price is Rs.110, anyone can buy in the cash market and sell in the futures market and make the riskless profit of Rs.10. This is called arbitrage and the individuals who practice arbitrage are called the arbitrageurs. Various research houses extend share market tips to help the arbitrageurs make money in the market.

The Rs.10 difference represents the cost of buying at Rs.100 today, selling at Rs.110 in the future, and repaying the amount borrowed to buy in the cash market with interest.

Arbitrageurs are specialist traders who evaluate whether the Rs.10 difference in price is higher than the cost of borrowing. If yes, they would exploit the difference by borrowing and buying in the cash market and selling in the futures market at the same time (simultaneous trades in both markets). This is basically suggested to them by the commodity tips providers. If they settle both trades on the expiry date, they will make the gain of Rs.10 less the interest cost, irrespective of the settlement price on the contract expiry date, as long as both legs settle at the same price.

After necessary approvals from SEBI, derivative contracts in Indian stock exchanges began trading in June 2000, when index futures were introduced by the BSE and NSE. In 2001, index options, stock options, and futures on individual stocks were introduced. India is one of the few markets in the world where futures on individual stocks are traded. Equity index futures and options are among the largest traded products in derivative markets world over. In the Indian markets too, volume and trading activity in derivative segments is far higher than volumes in the cash market for equities. Other highly traded derivatives in global markets are for currencies, interest rates and commodities.