An Arbitrage Fund profits from price differences between the cash and futures market — it simultaneously buys stock in the cash market and sells in the futures market, locking in a small but near-riskless return.
Arbitrage funds exploit the price gap between buying a stock in the cash equity market and simultaneously selling it in the futures market. This gap exists because futures prices typically trade at a slight premium to cash prices (called the 'cost of carry'). The fund locks in this spread risk-free and earns a return similar to short-term debt instruments. Since the portfolio is predominantly equity (maintaining ≥65% equity for taxation purposes), arbitrage funds are taxed as equity — LTCG after 12 months.
Suppose Infosys shares trade at ₹1,800 in the cash market and futures contracts for next month trade at ₹1,815. An arbitrage fund buys the shares at ₹1,800 and simultaneously sells the futures at ₹1,815. When the month ends, the prices converge — the fund earns the ₹15 difference (0.83% return) regardless of where the stock moves. Thousands of such trades generate a steady, low-risk return for the fund.
Buy stock in cash market; simultaneously sell equivalent futures of the same stock.
At futures expiry, positions close — the spread captured is the fund's return.
Equity tax treatment because ≥65% is in equity — beneficial vs debt fund taxation.
Returns are steady (5–7% p.a. typical) but not fixed.
Best compared to liquid or ultra-short duration funds as an alternative for short-term parking.