Question

Show that, if the futures price of a commodity is greater than the spot price during the delivery period, then there is an arbitrage opportunity. Does an arbitrage opportunity exist if the futures price is less than the spot price? Explain your answer.

Answer 1

When the future price of a commodity is greater than the spot price during the delivery, then shot the future which makes you liable to deliver the commodity at maturity. Buy the commodity at market price and make the delivery at a higher rate i.e. at future price. Hence a profit is booked of amount (future Price - Spot Price) without any risk taken which is an arbitrage opportunity.

When the future price is less than the spot price then take the opposite position on the contract i.e. to buy the future. At maturity, you will be receiving the commodity which is lesser than the spot price as future price lower than it. Then sell the commodity in market and book a profit of (Spot Price - Future Price). The profit is booked without any risk taken which makes it an arbitrage oppurtunity.