Arbitrage possible in uniform settlements

Sujoy Manna & Prashant Kothari

Mumbai, May 16: THE introduction of uniform settlement cycle might not completely wipe out the arbitrage facility between exchanges. Inter-exchange arbitrage is still possible if bourses adopt different settlement cycles and also with the difference in demand and supply situation of stocks between exchanges.

Let us consider the following hypothetical example, suppose there are two exchanges B and N with exchange B having a T+5 settlement cycle (Monday to Monday) while exchange N has a T+3 settlement cycle (Monday to Thursday). Now under this scenario an individual investor who has built up a position on exchange B on Monday has to settle it next Monday.

Assuming further that the price of a stock is higher on exchange B as compared to exchange N then the investor can sell a stock on exchange B and buy the same on exchange N. There would be no default by the investor in giving delivery to exchange B since he would receive delivery of shares from exchange N before his obligation to deliver shares to exchange B. Thus a difference in settlement cycle would lead to arbitrage between exchanges.

The inter-exchange arbitrage is also possible if there is a sharp difference in demand and supply for a particular stock in two exchanges with same the settlement cycle. This would be possible only in illiquid counters since the price differential in such stocks would be much higher as compared to liquid counters. However, such an arbitrage would take place only when there is a good chance of the price reaching an equilibrium at both the stock exchanges.

Sebi at its recent board meeting has decided to introduce the uniform settlement cycle with effect from July 2, 2001 to reduce arbitrage opportunities which existed due to different trading periods of various exchanges.