A fund holds Rs 50 crore of a stock at Rs 600. The one-month future trades at Rs 597, while carry at 7% says it should be about Rs 603.50. How does switching from the shares into cash plus futures earn extra return, and what if the discount has not closed by expiry?

The switch adds about Rs 54 lakh, 1.1% of the holding in one month, whatever Aundha does. The cash grows to Rs 603.50 a share and the futures, bought at Rs 597, pay the expiry price less 597, so the fund ends with the share price plus Rs 6.50. At expiry the future must settle at the share price, so the discount always closes by then; the risks are having to unwind early, costs, and a dividend that would explain the discount.

Imagine a dealer offers to sell you your own scooter back in a month for Rs 597, today, while you can sell it now for Rs 600 and earn a month's interest on the cash. You would sell, bank the Rs 603.50 the cash grows to, and take the scooter back for Rs 597. A future is a promise to buy the shares at a fixed price on expiry, so the fair price is the share price plus a month's interest on it, about Rs 603.50; at Rs 597 the market is selling the shares forward Rs 6.50 too cheaply. The fund can take that gift without changing its exposure to Aundha.

Because at expiry the future settles at the share price. Each share's worth of cash has grown to Rs 603.50, and each share's worth of futures pays the expiry price less Rs 597. Add them and the fund holds the expiry price plus Rs 6.50 a share; holding the shares would have given just the expiry price, so the difference is fixed on the day the switch is done. The table works three outcomes to show the gap does not move. Lots come in 500 shares, so 1,666 lots cover 833,000 shares and the fund keeps the remaining 333 shares as stock.

It cannot stay open at expiry: the future's final settlement price is set from the share price at the close, so the gap is forced to zero on that day. Depending on the contract's settlement terms, the fund either takes delivery or buys its shares back at that same closing price, and it ends where it started, holding Aundha, with the Rs 6.50 a share banked. The discount can widen before expiry, and if the fund has to unwind early, for example to meet heavy redemptions, it sells the futures at whatever discount then prevails and the gain can shrink or turn into a loss. Held to expiry, the gain is fixed; unwound early, it is a bet on the discount.

Four checks before doing it. First, the dividend: if Aundha is expected to pay about Rs 6.50 a share before expiry, the future should trade Rs 6.50 lower and there is no gift at all, so confirm the corporate action calendar. Second, costs: selling and later buying back Rs 50 crore of shares and trading the futures carries brokerage, taxes and market impact; at an assumed 0.10% in all, about Rs 5 lakh, the switch still adds roughly Rs 49 lakh, but the fund must use its own schedule. Third, margin: the exchange will hold part of the parked cash as margin and settle losses daily, so the cash must stay liquid. Fourth, the annualised figure, about 13% a year extra, is a reason to ask why the discount exists, usually because many holders want to do the same trade, and the trade is only as large as the futures market can take without closing the gap itself.