Premium and Discount Arbitrage

Premium and discount arbitrage involves exploiting instances where a derivative is trading at an abnormal premium or discount relative to the spot price. When the derivative is at a significant premium, traders sell the derivative and buy the spot asset to capture the spread as it returns to normal.

When it is at a discount, they do the opposite, buying the derivative and selling the spot. This strategy requires identifying when the premium or discount is driven by temporary market inefficiencies rather than fundamental changes in value.

It is similar to basis trading but often focuses on shorter-term price dislocations. Success depends on the ability to execute trades quickly before the market corrects itself.