Introduction and legality of Arbitrage trading in India

Arbitrage trading involves buying an asset from an exchange where it is listed at a lower price and selling the same asset on another exchange where it has a higher value. This process allows traders to leverage the price difference of an asset listed on different platforms.

Such opportunities arise due to discrepancies in the demand and supply of securities on various platforms. One can purchase assets like stocks, commodities, currencies, futures contracts, and more.

The profit of the arbitrageur, a term used for traders performing arbitrage, is the difference in the price of an asset in the two markets. Although this price difference may seem small, even the slightest profit margins can result in impressive profits when traded in large quantities.

For instance, if the International Telecom Ltd. stocks are trading at ₹218/share on the BSE and ₹222/share on the NSE, you can buy 1000 shares from the BSE and sell them on the NSE to take advantage of the price difference. This is called arbitrage trading.

While arbitrage trading is legal in India, there is a catch. SEBI (the Securities and Exchange Board of India) does not allow the buying and selling of the same company’s stocks on the same day on different exchanges. Therefore, intraday arbitrage trading isn’t allowed in India.

To perform arbitrage trading in India, you must first have the target stocks in your Demat account. If you spot a price difference on either of the stock exchanges, you can sell them to book profits. Then, you can buy back the shares from the exchange at a lower price to facilitate their delivery. In this way, one can earn profits and adhere to SEBI’s guidelines.

To sell shares intraday on the BSE, you need to either purchase them on the BSE or already have them in your demat account.

Suppose you notice a price difference for a particular stock between the NSE and BSE, with the stock trading at ₹105 on the NSE and ₹100 on the BSE.

Even though the opportunity to buy on the BSE and sell on the NSE may seem tempting, it is not possible due to regulatory restrictions. However, if the stock is already in your Demat account, you can sell it on the NSE for ₹105 and then buy it back on the BSE for ₹100.

Arbitrage trading is legal in India as long as you take delivery of shares. SEBI promotes such activities as it helps maintain the same prices of securities across different exchanges.

Types of arbitrage

 They include pure, futures, dividend, merger, and retail arbitrage.

Pure arbitrage 

It involves simultaneously buying and selling the same security in different markets to take advantage of price differences.

Futures arbitrage 

It is buying an asset in the cash market and selling its futures when the price of the asset in the futures market is greater than its price in the cash market.

Dividend arbitrage 

It involves buying shares before the ex-dividend date and buying puts in the appropriate proportions.

Merger arbitrage 

It involves buying shares of the company being acquired and selling shares of the acquiring company.

Retail arbitrage 

It involves buying goods from one merchant at a low price and selling them to another merchant at a higher price.

What are arbitrage funds?

Arbitrage funds are mutual funds that invest in both equity and debt assets. They aim to take advantage of price differences between assets on two exchanges or the cash and futures markets.

Examples of arbitrage funds in India

Fund Name	AUM	NAV	5-Year Returns
Edelweiss Arbitrage Fund	Rs 8,768 crore	Rs 7.04 lakh	6.33%
Nippon India Arbitrage Fund	Rs 13,854 crore	Rs 7.02 lakh	6.20%
Invesco India Arbitrage Fund	Rs 14,593 crore	Rs7.06 lakh	6.42%
Kotak Equity Arbitrage Fund	Rs 39,099 crore	Rs 7.04 lakh	6.32%
Tata Arbitrage Fund	Rs 10,152 crore	Rs 7.03 lakh	6.29%
Axis Arbitrage Fund	Rs 3,966 crore	Rs 7.01 lakh	6.15%
Aditya Birla Sunlife Arbitrage Fund	Rs 10,668 crore	Rs 7 lakh	6.13%
HSBC Arbitrage Fund	Rs 2,012 crore	Rs 6.99 lakh	6.07%
ICICI Prudential Equity Arbitrage Fund	Rs 17,500 crore	Rs 6.99 lakh	6.07%
Bandhan Arbitrage Fund	Rs 5,768 crore	Rs 6.99 lakh	6.07%

Above is the list of some of the best arbitrage funds in India; it’s based on their 5-year annualised returns as of March 19, 2024. Source: etmoney

Arbitrage funds taxation in India

According to the tax laws in India, arbitrage funds are considered as equity schemes. This means that any profits you make from selling these fund units are subject to Capital Gains Tax.

If you sell the assets within one year from the date of purchase, you will have to pay Short Term Capital Gains (STCG) tax of 15%. However, if you hold the units for a year or more and then sell them, you will have to pay Long-Term Capital Gains (LTCG) tax. The tax rate for LTCG is 10% for profits exceeding Rs.1 lakh.

Risks involved with Arbitrage trading in India

Arbitrage trading requires a large capital investment, which is often not feasible for retail investors. Even if the capital is available, high transaction fees can eat into profits. Additionally, finding arbitrage opportunities can be challenging for retail traders who lack advanced trading software. One must keep in consideration these factors while doing Arbitrage trading in India.