ANALYSIS OF

ARBITRAGE
OPPORTUNITIES
IN BANKING
SECTOR
OBJECTIVES
● To check whether arbitrage opportunity exists in prices of derivatives of
the 3 banks -PNB, HDFC and ICICI during the period (May, 2015 -
May,2020)

● To analyse the trends of monthly future prices of above-mentioned banks

● Forecasting their prices for 24 months.

Introduction
❏The future derivative trading on stock indexes has grown rapidly since inception and
provides important economic functions such as price discovery, portfolio diversification
and opportunity for market participants to hedge against the risk of adverse price
movements.

❏Hence, the movements of spot market price have been largely influenced by the
speculation, hedging and the arbitrage activity of futures markets.

❏Thus, understanding the influence of one market segment on the other and role of each
market segment in the price discovery is the central question in the market
microstructure design and has become increasingly important research issue among
academicians, regulators and practitioners alike as it provides an idea about the market
efficiency, volatility, hedging effectiveness and arbitrage opportunities.
❏ In a perfectly efficient markets, every piece of new information is reflected simultaneously in the underlying spot market
and future markets. Further price adjusts instantly and fully to new information.

❏ Henceforth it suggests that arbitrage opportunities are not possible and no lead- lag relationship establish between the
spot and futures market.

❏ Future market also spreads the shocks across markets. Correspondingly due to market frictions such as institutional
settings of the financials of the financial market, differences in transaction cost; capital market microstructure effects etc.

❏ Significant lead-lag relationship has been observed between two markets. One market reflects new information than
the other and carries important information for the traders enabling them to leverage arbitrage profit in the market. If
the response exists between spot and future market, it is possible that investor can also use past information to
predict future prices in the spot market.

❏ If the response exists between spot and future market, it is possible that investor can also use past information to
predict future prices in the spot market.
The spot price and the futures price
of the contract converges as the
delivery period of the futures
contract of the underlying asset is
approached. The futures and spot
prices are equal or very close to
each other, this is theoretically
because there should be no
arbitrage opportunity.
Literature Review
1) Price Discovery in NSE and Spot and Future Markets of India (2010)

By - P. Srinivasan-BHAVAN’S INTERNATIONAL JOURNAL OF BUSINESS

2) Price Discovery and Arbitrage efficiency of Indian Equity futures and cash
market

By - Kapil Gupta and Dr Balbinder Singh NSE Research paper, 2009

3) Derivatives and Volatility on Indian Stock Markets (2003)

By - Snehal Bandivadekar and Saurabh Ghosh-Reserve Bank of India

Occasional Papers Vol. 24
Methodology
Time period - May,2015 to May,2020

Source - National Stock Exchange website

What - Spot prices , Futures prices of HDFC Bank , ICICI Bank, PNB Bank

Analysis tool- R , ARIMA , MS Excel

Assumptions

1. We have squared off our position in the futures contract in the month itself.

2.We have taken average of 91 days treasury bill for calculating r for fair future prices.

3.We have taken monthly data of spot and future prices.

4.We have assumed that there is no dividend paid by the banks during this year and there is
 Where

F0 = Theoretical price of the futures contract

Fair Future Price S0 = Spot Price of the underlying asset

R = Risk free rate

T = Time until maturity

Implications:
● If actual fair price > theoretical fair price, then investor go long in spot market and short in
future market at t=0 and at t=T i.e final settlement day he will square off his position.

● If actual future price is lower than theoretical future price , then investor will go for long in
future market and shot in spot market with opportunity cost = invest spot.

● In both case investor registers arbitrage gain by exploiting the difference between the spot
and future market price of the same equity.

● The increase in demand/ supply of the futures (and spot) contracts will force the futures
price to equal the fair value of the asset.
ARIMA
ARIMA (Autoregressive Integrated Moving Average) is an autoregression model where we
use linear combinations of past values of a particular series, to arrive at future values.
(regression of the variable against itself).

The stationary time series is the one which is independent of time at which we study the
series. So, for those times when we find a non – stationary series or a series which
increases or decreases with time, we need to convert it to a stationary series by
differencing it.

Differencing a series helps in stabilising the mean of the time series by neutralising the
trend or seasonality in the series.

Differenced Series : y’t = yt – yt-1

Analysis of Arbitrage Opportunities in HDFC Bank
● In Aug-19 as the future rate and fair future
overlap each other the possibility of
arbitrage falls to almost 0 and after that it
shows the consistent trend.

● It tells us that there is condition of contango

was experienced for a long time. It stated
that there was a bullish market for HDFC

● The volume of trading had been also

increased for those 4 years as the investors
need to hedge their risk of price reduction in
spot market by simultaneously entering into
short future derivatives
 The Rise :

● HDFC Bank’s retail portfolio has shown

a growth of around 7 per cent
compared to previous years.
● mortgage finance which is more or less
an organised market.The mortgage
finance rate has come down to from
7.3% to 6.7%, making owning property
attractive once again only from the
perspective of cheap interest rates.
The fall :

● after the NBFC Crisis, a lot of the small players in this segment have got washed
out.
● And the covid Crisis.
Analysis of Arbitrage Opportunities in PNB Bank
There has been negative trend in the
future rate and the fair future price
during the period

the futures price and fair futures price is

almost colliding each other which provide
less opportunity to the arbitrageurs

the growth in both equity and derivative

market was observed significantly but
after fraud registered, market balance of
PNB was very unstable and led to lower
profit margin and hence share prices fell
significantly.
 The Rise :
● In Sept 2017, there has been a sharp
increase in the futures prices and thus
arbitrage because PSU banks stocks
rally on recapitalisation plans, SBI,
PNB shares surge up to 36%.

The fall :

● the Nirav Modi fraud hit bank posted profit

of Rs 363.34 crore during 2019-20.
● The bank has scaled down its loan growth
target to 6 per cent for the current fiscal
due to the COVID-19 crisis.

● Possibility of arbitrage was reduced significantly for this as it had been claimed against several
fraudulent charges that dissolved the market valuation hence low trading in derivative market.
Analysis of Arbitrage Opportunities in ICICI Bank
There has been upward trend in the
future rate and the fair future price
from the period (May-15 to May-20).
For the year 2015-2017, there the slight
chances for arbitrage existed vary
between 20-30 points but after that
market became very efficient and no
arbitrages existed and less risk in the
market and hedging was also brought
down with the less arbitrages
 The fall :
● The gross NPAs has increased from
3.12% to 3.77%
● The bank’s restructured asset base
decreases from 12,604 cr to 11,868 cr.
● RBI has held ICICI bank that the
shifting of securities the second time in
May,17 without explicit permission was
in contravention of RBI directions.

The Increase :
● Consistent increase of Net profit from 2015 to 2017.
● the sale of a 9% stake in ICICI Lombard General Insurance Company to its
joint venture partner Fairfax Financial Holdings Ltd.
● Net interest income to around rose 13%
Forecasting Using Future Prices of Futures Contracts: HDFC
Reasons for such trend:
Positive
Improvement in its gross non performing asset (GNPA) ratio
and of its NBFC subsidiary HDB Financial Services mainly led
by heavy write-offs.
Showed a solid balance sheet than most of its competitors.
Negative
A fresh Covid wave can potentially disrupt the recovery of
businesses.
HDFC retail growth, which was at 6.7 per cent year on year as
against industry growth of 9 per cent.
RBI,barred HDFC Bank from new digital launches and
issuances of fresh credit cards in December last year due to
frequent outages in HDFC Bank’s digital services reported over
the last two years and stopped all launches under its Digital
2.0 initiative.The ban on issuing new creditcard impacted the
bank as the card business contributes 15% of core operating
profit growth
 Forecasting Using Future Prices of Futures Contracts: PNB Bank
Punjab National Bank has had a high bad loan
ratio for more than five years.

The company's asset quality witnessed

deterioration, with the gross non-performing
assets (NPAs) increased to 4.44 per cent of the
gross loans at end of March 2021 from 2.75 per
cent in the same period of 2019-20.

Punjab National Bank (PNB), the country’s second

largest bank following merger of Oriental bank of
Commerce and Union Bank of India, expects to
recover about ₹16,000 crore by March 31, 2021,
including ₹ 8,000 crore through the National
Company Law Tribunal (NCLT) under IBC cases.
Forecasting Using Future Prices of Futures Contracts: ICICI Bank
ICICI is firmly positioned to deliver healthy growth, led by
core operating performance. For the March quarter of FY21
reported 261% increase in its year on year net profit.
It enjoys a healthy loan growth and margins which leads to
healthy profitability.
Underlying asset quality trends of the bank is also solid.
The launch of ICICI Bank Merchant Stack, a set of digital
banking services especially curated for retail merchants is a
value addition to the companies as it enables merchants -
grocers, super markets, large retail store chains, online
businesses and large e-commerce firms - to meet their
banking requirements so that they can continue to serve
their customers during the pandemic.
This initiative is in-line with the Bank’s principle of ‘Business
with Care’. ICICI Bank also held a 70% share in new credit
cards issued in December 2020.
CONCLUSION
According to our analysis, it can be concluded there exists different trend of
arbitrage opportunities for different banks. We have also concluded that there is
slight convergence of spot and future prices at the time of expiry for PNB bank.
However, in the case of ICICI and HDFC bank for the starting half of the time
period taken into consideration the spot and futures prices do not converge
which reflects that there is high arbitrage opportunity present in these two banks.
Based on the current future price, we can determine the future demand and
supply of the shares.
➔HDFC BANK
● For the year 2015 - 2019 , the future price is overvalued hence there was high
profitability for the investors with higher arbitrage gap investor took short position
in future market and long position in the spot market and at the settlement date he
squared off his position

● The highest profit gained by the investor was reported during the year 2018 - 2019
and the lowest profitability in term of arbitrage was reported during the year 2020

● Among these all banks we can definitely conclude that HDFC Bank is profitable.
➔PNB BANK
❖ We have founded that , there were several instances when there was total
convergence of spot and future prices were obtained, It clarifies that less
arbitrage opportunity existed for this bank.

❖ Hence,for investors the profitability was also reduced as comparison to HDFC

Bank.

❖ The lower value of Future Price and Spot Price indicates that low profit margin ,
lesser speculation & henceforth it reduces the market valuation of PNB Bank.
➔ICICI BANK
● For the year , 2015 - 2017 there was perfect cash and carry arbitrage existed. Hence it
accounted for lower riskless profit through arbitrage exploitation.

● For the year , 2017 - 2019 there was a strong positive convergence of spot and future
price that meant to be good for hedging and reducing the risk of market volatility.

● We have also accounted negative arbitrage that means security is undervalued , so it

was assumed that investors had taken long position in the future market and short
position in spot market and after squaring off at the settlement date they gained
through arbitrage.
THANK YOU
HANK-YOU