Arbitrage
Buying and selling the same thing in two markets to capture a price gap, and how arbitrage funds use it
AMFI data as on 31 August 2026; rules as on 12 October 2026
Verified 12 October 2026
For training and education only. Not investment advice.
Trainer notes
Say this at the start: Trustner is a mutual fund distributor. We distribute arbitrage funds as mutual fund schemes; we do not distribute or recommend derivative trading. This deck explains what the word means, why the gaps exist, what can go wrong, and how an arbitrage fund is built and taxed.
Arbitrage is buying in one market and selling the same thing in another at the same time, to capture a gap.
The trader takes no view on whether the price will rise or fall. The gaps are usually small and close quickly. The trade is not free of risk.
Trainer notes
The two trades together are what make it arbitrage. Buying in the hope of selling higher later is not arbitrage; it is a view on the price. The risks are covered on slide 6: do not let the room leave with the phrase 'risk-free'.
Where the price gaps come from
Two exchanges
The same share trades on two exchanges. If the two prices differ for a moment, a trader buys on the lower one and sells on the higher one.
Cash and futures
A share and its future are prices for the same thing on two dates. If the future is priced above the share by enough, buy the share and sell the future.
Why gaps close
Buying pushes the lower price up and selling pushes the higher price down. The trade itself narrows the gap, usually quickly.
Trainer notes
The cash market is where shares themselves are bought and sold. A future is a contract to buy or sell later at a price fixed today (see the Futures deck). Gaps between two exchanges are tiny and close within moments. The cash-and-futures gap is the one arbitrage funds work with, so the rest of the deck follows that.
A cash-and-futures arbitrage
THE TWO TRADES
An invented share is at ₹1,000. Its one-month future is at ₹1,006.
A trader buys 1,500 shares for ₹15,00,000 and sells futures on 1,500 shares at ₹1,006.
All figures are assumed.
- The gap locked in: (1,006 − 1,000) × 1,500 = ₹9,000. At expiry the future settles at the share's price.
- Share at ₹1,100 on expiry: shares gain ₹1,50,000; futures lose (1,100 − 1,006) × 1,500 = ₹1,41,000. Net: ₹9,000.
- Share at ₹900 on expiry: shares lose ₹1,50,000; futures gain (1,006 − 900) × 1,500 = ₹1,59,000. Net: ₹9,000.
- ₹9,000 on ₹15,00,000 is 0.6% for the month, before brokerage, taxes and the cost of margin.
Result: The gap was the same whichever way the price went. Costs and taxes come out of it.
Illustration with an invented share and assumed prices. Not an indication of the gap or return available.
Trainer notes
The ₹9,000 holds only if both trades are done at these prices and both are held to expiry. The futures leg needs margin, and its daily losses must be paid in cash: in the second step the trader pays ₹1,41,000 over the month while the gain on the shares is still on paper. The 0.6% is an assumed figure for the arithmetic, not a typical one.
Why a future usually prices above the share
Interest until expiry
A buyer of the future does not pay for the shares today. The futures price reflects the interest on that money until expiry.
The theoretical price
NSE's formula is F = S × e^(rt): the cash price S, grown at an interest rate r for the time t left to expiry.
Dividends pull it down
The holder of a future receives no dividend. A dividend expected before expiry lowers the futures price against the cash price.
The gap closes at expiry
A future is finally settled at the closing price of the underlying, so the two prices meet on the last trading day.
Take-away: The gap between the two prices is called the basis. It is roughly an interest rate, not a windfall.
Source: NSE Clearing, equity derivatives settlement mechanism and settlement price pages, read 12 Oct 2026.
Trainer notes
This is called the cost of carry. NSE uses the formula for the daily settlement price of futures that did not trade in the last half hour, with MIBOR, an interbank rate, as r. The market price of a future can sit above or below the theoretical price. At times a future trades below the share; the buy-shares, sell-futures trade then has no gap to capture.
What can go wrong
| Risk | What happens |
|---|---|
| Execution | The two trades are separate orders. If one is done and the other is late or only partly done, the position is exposed to the price. |
| Margin calls | The futures leg is settled in cash every day. If the price rises, cash must be paid on the futures while the gain on the shares is on paper. |
| Early exit | The two prices must meet only at expiry. Before that the gap can widen, so closing early can return less than the gap, or a loss. |
| Costs | Brokerage, taxes and charges come out of a thin gap. STT on a futures sale rose from 0.02% to 0.05% of the price on 1 April 2026. |
| Crowding | When more money chases the same gaps, the gaps shrink. The gap on offer changes from month to month. |
Sources: NSE Clearing settlement pages (read 12 Oct 2026); NSE circular NSE/FATAX/73524, 31 Mar 2026 (Finance Act, 2026).
Trainer notes
STT is securities transaction tax; the seller of the future pays it. A stock future held to expiry is settled by delivery of shares, so a fund can close both legs, roll the futures to the next month, or let the position run to delivery of the shares it holds. Rolling means buying back this month's future and selling next month's, at whatever gap is then on offer. Arbitrage reduces price risk; it does not remove these risks.
How an arbitrage fund is built
- 65%
Equity
At least 65% of total assets is in equity and equity-related instruments. Usually, shares bought are matched by futures sold.
The rest
Debt held for liquidity and margin, e.g. CDs, government securities up to 1 year, liquid or money-market scheme units.
The return
Mainly the gap between cash and futures prices, less costs. It moves with the gaps on offer and is not assured.
Take-away: Trustner distributes mutual funds. It does not distribute or recommend derivative trading.
Source: SEBI Master Circular for Mutual Funds as on 20 March 2026: scheme category table (hybrid schemes) and paras 13.18.1 and 13.18.6.
Trainer notes
SEBI places arbitrage funds among hybrid schemes: 'scheme following arbitrage strategy'. The buy-shares, sell-futures description is the usual strategy, not SEBI's wording. A scheme's total exposure cannot exceed 100% of net assets; a hedge with the same underlying, no larger than the holding, is exempt. SEBI names the 1-year Treasury bill as the additional benchmark for arbitrage funds. An arbitrage fund may not invest in InvITs. The NAV is market-linked and can fall over short periods, for example when the gap widens or trades are rolled at thin gaps.
Where arbitrage funds stand
Industry figures for the arbitrage fund category, August 2026.
- SCHEMES
- 40Arbitrage fund schemes as on 31 August 2026.
- AUM, ₹ LAKH CRORE
- 3.02Net assets of ₹3,02,175 crore on 31 August 2026 (month-end, not average).
- FOLIOS, LAKH
- 9.379,36,561 investor accounts in the category on 31 August 2026.
- NET INFLOW, ₹ CRORE
- 3,789Sales less redemptions in the month of August 2026.
Source: AMFI, Monthly Report for August 2026 (hybrid schemes, arbitrage fund row). Industry net assets on the same date: ₹87.08 lakh crore.
Trainer notes
Refresh from AMFI's monthly report before each session; the September 2026 report was not on AMFI's site when this deck was written. The category's average net assets for August were ₹3,56,862 crore, higher than the month-end figure: say which basis a number is on. A folio is an account, not a person. Arbitrage funds were about 3.5% of industry net assets (3,02,175 ÷ 87,07,888). Flows into a category say nothing about its future returns.
How an arbitrage fund is taxed
- 20%
Held 12 months or less
The gain is short-term and is taxed at 20%.
- 12.5%
Held over 12 months
The gain is long-term. Tax is 12.5% on such gains above ₹1.25 lakh a year, counted across all equity holdings.
- 65%
The test behind it
These rates apply to a fund with at least 65% in listed domestic equity shares. The shares an arbitrage fund buys count.
Take-away: Tax rules change and depend on the investor. This is general information, not tax advice.
Source: Income-tax Act, 2025, sections 196 and 198; rates in force since 23 July 2024, as set out in a fund-house tax reckoner for FY 2026-27 (secondary).
Trainer notes
An arbitrage fund is taxed as an equity-oriented fund although its return behaves more like a short-term interest rate. That holds only while the scheme meets the 65% test, measured on its holdings of listed domestic equity shares; futures positions do not count towards it. Surcharge, where it applies, is extra. STT of 0.001% is charged on redemption of equity-oriented fund units. Do not present the tax treatment as a reason to invest.
If you learnt this from older material
What older decks say
- Arbitrage is a profit without risk.
- Long-term gains on equity funds are taxed at 10%.
- STT on a futures sale is 0.02%.
- NSE futures expire on the last Thursday.
What holds now
- The gap is fixed at the start; costs, timing and margin calls are not.
- 12.5% on gains above ₹1.25 lakh a year, from 23 July 2024.
- 0.05% from 1 April 2026, a higher cost on each futures sale.
- The last Tuesday, for expiries from 1 September 2025.
Sources: NSE circular NSE/FATAX/73524 (Finance Act, 2026); NSE circular NSE/FAOP/68747, 25 Jun 2025; tax rates as on the previous slide.
Trainer notes
Older material explains arbitrage with a seller who buys a cup of tea in one place and sells it dearer in another. That shows the idea of two prices for one thing, but leaves out what matters in a securities market: the two trades are made together, the gap is thin, and costs and margin decide what is left.
Four things people get wrong
Misconception'Arbitrage is risk-free.'
What is truePrice risk is largely offset. Execution, margin calls, early exit and costs remain, and any of them can remove the gap.
Misconception'An arbitrage fund cannot fall.'
What is trueIts NAV is market-linked and can fall over short periods, for example when the gap widens. Returns are not assured.
Misconception'It is a debt fund.'
What is trueSEBI classes it as a hybrid scheme with at least 65% in equity and equity-related instruments, and it is taxed as equity-oriented.
Misconception'The fund bets on futures.'
What is trueThe futures are sold against shares the fund holds, so the two largely offset each other. The aim is no view on direction.
Take-away: An arbitrage fund is a market-linked product. Read the scheme documents before investing.
Trainer notes
If a client asks whether an arbitrage fund is 'like a fixed deposit': it is not. There is no assured rate, the NAV moves daily, and the return depends on the gaps on offer. Say what it holds, how it is taxed and what can go wrong. Trustner does not distribute or recommend derivative trading; an arbitrage fund is a mutual fund scheme run by a fund manager within SEBI's limits.
Check yourself
Question 1: An invented share is at ₹800 and its future at ₹804. A trader buys 2,000 shares and sells futures on 2,000. What gap is locked in, in rupees and as a % of the share cost?
Answer: (804 − 800) × 2,000 = ₹8,000. The shares cost ₹16,00,000, so the gap is 0.5%, before costs. Check at ₹700 on expiry: shares lose ₹2,00,000, futures gain ₹2,08,000, net ₹8,000.Question 2: Brokerage, taxes and other charges on those trades come to an assumed ₹3,200. What is left, in rupees and as a percentage?
Answer: ₹8,000 − ₹3,200 = ₹4,800, which is 0.3% of ₹16,00,000. Costs took 40% of the gap.Question 3: A client says: 'An arbitrage fund is risk-free and its returns are fixed.' Name two things you would correct.
Answer: Returns are not assured: they depend on the gap between cash and futures prices, less costs. And it is not free of risk: the NAV can fall over short periods, and execution, margin and cost risks remain.
Sources and disclaimer
Sources for the figures in this explainer
- Futures pricing and settlement: NSE Clearing, equity derivatives settlement mechanism and settlement price pages, read 12 Oct 2026.
- Arbitrage fund category and exposure limits: SEBI Master Circular for Mutual Funds as on 20 March 2026 (scheme category table; paras 13.18.1, 13.18.6 and 14.2.4).
- Category size: AMFI, Monthly Report for August 2026 (schemes, folios, net inflow and net assets under management as on 31 August 2026).
- Securities transaction tax: Finance Act, 2026, per NSE circular NSE/FATAX/73524. Expiry day: NSE circular NSE/FAOP/68747 (25 Jun 2025).
- Capital gains tax on equity-oriented funds: Income-tax Act, 2025, sections 196 and 198; rates as set out in a fund-house tax reckoner for FY 2026-27 (secondary).
- The shares, traders, prices, quantities and costs in the examples and quiz are invented for the arithmetic only.
This material is for training and investor education only. It is not investment, tax or legal advice and is not a recommendation to buy, sell or hold any security or scheme. Examples use assumed figures unless a source and date are shown. Mutual fund investments are subject to market risks; read all scheme related documents carefully. Trustner Asset Services Pvt. Ltd. is an AMFI-registered Mutual Fund Distributor (ARN-286886).