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Arbitrage


Simultaneous purchase and sale of an asset in order to profit from a difference in the price is called Arbitrage. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms.

DGCX provides SDMA setup for large corporate clients where a client can have API connections with exchange and co-locate their server with DGCX for a better connectivity and faster trade execution.

Indian Rupee vs. US Dollar is a favorite arbitrage product at DGCX.

INR/Dollar contract which is also known as DINR is traded on DGCX (Dubai Gold & Commodities Exchange). This contract is a Future contract and has all the specifications as any Exchange Traded Instrument. Same INR/Dollar contract is also traded in NDF Market (Non Deliverable Forward Market) which is basically an OTC (Over the counter) market based in Singapore and Hong Kong.

In the strategy, an arbitrage is created between these two contracts.

DINR vs. OTC Contract

  • Both the contracts are cash-settled
  • RBI reference rate is used for the settlement
  • Settlement takes place on the last day of the expiry of DGCX contract


How Strategy Works

Say, on a particular day, rates in both the markets are as following:

  Rate Converted Rate
DINR 174.13 57.1000
NDF 57.0000 57.0000


In such a scenario, the trader would sell the contract in DGCX and buy the same in NDF Markets, and thus locking a profit of 10 paisa.

Now, if this difference comes down, the trader can reverse the position i.e. Buy in DGCX and Sell in NDF and thus can square-off the position or he can simply wait for the Expiry as Settlement would take place at RBI reference rate in both the markets and thus can realize the locked profit on Expiry.

Assuming margin of 5% in both the contracts, this locked difference translates into a return of 1.75%.

In practice, the trades would take place as and when an opportunity comes and would be squared off at small profits. This would be done a number of times in a month so as to capture annualized returns of 12 18 % net of expenses.

Thus, the strategy is basically a near risk free arbitrage strategy.

Features of strategy:

  • Near risk free arbitrage strategy
  • Position would be created as and when any opportunity arises
  • Use of in-house tools for entry and exit


Advantages:

  • Near risk free arbitrage
  • Easy to enter and exit
  • Striking returns as compared to interest rates in International Markets (1%-2%)
  • Huge liquidity in both the markets so bigger funds can be easily deployed
  • Lesser margin requirements as a percentage of exposure
  • As contracts are traded in the same currency, there is no risk of currency fluctuation


Risk Associated:
  • Margin Requirements - In case of higher volatility, there can be MTM losses and profits in any of the market, therefore, enough cushion is required.
  • Liquidity Risk Though, there is enough liquidity in both the markets, but there might be a case when liquidity dries up, in such situation, frequent churning would not be possible.
  • Execution Risk The impact cost associated of price movement while executing all the legs of the trades.