*This article uses historical data in order to create a positive basis arbitrage opportunity because short selling of shares is restricted in Bursa Malaysia.
Assume it is now 17 January 2002 and the KLCI is at 1146.0. The risk-free interest rate is 5% per annum. The weighted average dividend yield of the KLCI is 2.3% per annum. What would be the fair value of the June 2002 KLCI futures contract (165 days to maturity)?
From the calculation above, the fair value (what the June futures contract should theoretically trading at) on 17 January 2002 is 1160.0. The actual quoted price of June futures however is 1192.5. The June contract is trading at a level higher than the fair value. The basis is positive where the futures contract is trading at a premium. If the futures was trading at a level below the fair value, then the basis is negative and the futures are trading at a discount. In either case, an arbitrage opportunity will become available.
So from this example, the following information is available:
| Spot price: | 1146.0 |
| Actual futures price: | 1192.5 |
| Theoretical futures price: | 1160.0 |
Thus, the June futures contract is mispriced. It is trading at 32.5 points above its fair value and 46.5 points above its spot price.
To take advantage of this situation, a trader would purchase the underlying stock and sell futures contracts in the transactions. Let's assume that the trader has RM 10,000,000.00 and this fund can be obtained at 5% risk-free rate. By using this fund, the trader purchases RM10,000,000.00 of stocks and sells futures at 1192.5 simultaneously.
The number of contracts to be sold can be calculated as follow:
Hence, the trader will sell 167 contracts. It is assumed that the position is hold until contract expiry and the futures and cash prices converge to 1165.0 at expiry.
| Cash Market | Futures Market |
17 January Buy RM 10,000,000.00 of stocks at 1146.0. | 17 January Sell 167 futures contracts at 1192.5. Value of futures = 167 x 50 x 1192.5 = 9,957,375 |
30 June Sell RM 10,000,000.00 of stocks at 1165.0. | 30 June Buy 167 futures contracts at 1165.0. Value of futures = 167 x 50 x 1165.0 = 9,727,750 |
From the table above, the result of the transactions can be illustrated as follow:
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