Question

On March 1, 2013, a trader buys a June 2013 gold futures contract at a price of $380 per ounce. The trader calculated the futures price range from the cost of carry model and found that this gold futures contract should trade at a price between $390 and $430. Which of the following statements about this June futures contract is correct?

		The trader can get quick arbitrage profits by engaging in either cash and carry strategy or reverse cash and carry strategy.
		The trader can realize arbitrage profits by engaging in a cash and carry strategy.
		The trader can realize arbitrage profits by engaging in a reverse cash and carry strategy.
		No arbitrage profits are possible to the trader from any trading strategy.
		None of the above statements is correct.

Answer 1

Answer: Option (2) The trader can realize arbitrage profits by engaging in a reverse cash and carry strategy.

Here futures are trading at $ 380 per ounce, while fair future price of gold calculated from cash and carry model ranges between $ 390 to $ 430, i.e., If Cash and carry strategy is applied we will end up investing $ 390 to $ 430 for ounce of Gold, where as we can purchase only for $ 390 through futures contract.

As there is a mispricing in futures market exists, Arbitrage profits can be made.

As Gold in Cheaper in futures market, The trader can realize arbitrage profits by engaging in a reverse cash and carry strategy.