The carnage has begun yet again, eh? As I write this, Nifty is down 2.2% and languishing at 5085.
To get away from these market swings and yet make money, there are certain special situations that we can take advantage of which can generate superior returns in an almost-risk-free way. One such opportunity is before us.
Read up this announcement by the IVRCL family. This announcement on the BSE, regarding the decision from the CCI is almost like a final approval before the deal goes through. There is a High Court order that needs to be given yet to make this official, but this looks like a formality (but there is a timeline risk – I cover that below).
Quick calculations. 6 shares of IVRCL A&H at today’s market price of Rs. 35 will cost Rs 210. 5 shares of IVRCL at today’s price of Rs. 46.45 will cost Rs. 232.25. So, net arbitrage profit percentage in this deal is 22.25/210 = 10.59%. The deal is expected to be completed in the next 1-2 months. Annualized would be around 60-70%. Great deal, eh?
Not so soon. Let’s just say we buy IVRCL A&H at Rs.35/- today. By the time the conversion happens, if the market turns and if IVRCL quotes at Rs.35 or below (look at the last 1 year stock price history), we make a loss. Our goal is to make market-neutral returns.
How do we ensure that there is risk-free arbitrage? Well, through IVRCL futures. We can buy shares of IVRCL A&H today and sell February/March IVRCL futures thereby ensuring market-neutral returns of 10.59% in 2 months.
Great. What is the catch? Well, there is no catch if you have lots of cash. Else, there is a catch. Futures get bought and sold in lots. One lot of IVRCL is 8000 stocks. That is, we can buy and sell IVRCL only in multiples of 8000 shares. Another complexity is in terms of margin. Since NSE has determined that IVRCL is volatile, the margin for buying/selling one lot of IVRCL is 30%. I illustrate the values in the figure below:
If we have to sell one lot (8000 shares) of IVRCL, we need to put up a margin of 30%*8000*46.45 = Rs. 1,11,480.
The number of shares that we need to buy of IVRCL A&H to satisfy the sell of one lot of IVRCL futures is 8000*6/5 = 9600 shares. This would cost us Rs. 35*9600 = Rs. 3,36,000.
Therefore to play this risk-free arbitrage opportunity, we need to put up a cash of Rs. 336000+Rs.111480 = Rs.447480/-.
The return calculations are rudimentary and the figure below illustrates that:
(Rs.22.25*1600 = Rs.35600)
Moral of the story: If you have idle cash of close to 4.5 lakhs, there is a risk free opportunity for the taking.
My moral of the story: I don’t have so much cash right now 🙂
Anyway, there are certain risks that we have to be aware of before we execute the trade:
a) There is a minute risk (very minimal actually, but scaring you nevertheless) that IVRCL might be taken off the futures list. If that happens, second leg of shorting the future has been eliminated and you would be exposed to pure stock risk.
b) The real risk is timeline risk. There is a high court approval that is yet to come and given our legal system, that might take time. In India, only the immediate next month futures are liquid. That is to say, if I were to execute this trade now, the most liquid futures would be the February futures. If the high court approval doesn’t come through, I will have to roll over this short futures position over to March, which will involve certain transaction costs (the way I understand this rollover is – you buy back the Feb futures, sell the March futures) and hence might eat into the returns. If it doesn’t come through by March, then roll over to April and so on and so forth, eating into the returns stated.