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Answer: Buy the futures, short Brent crude at spot, and take delivery against the futures at settlement.
## Explanation When futures are trading below the spot price (a condition known as **backwardation**), the correct arbitrage strategy is to: - **Buy the futures** (since they are cheaper than spot) - **Short sell the asset at spot price** (sell at the higher current price) - **Take delivery** against the futures contract at settlement This creates a **risk-free arbitrage profit** because: - You sell the asset at the higher spot price - You buy it back at the lower futures price - The profit equals the difference between spot and futures prices **Why other options are incorrect:** - **Option A**: This would be profitable if futures were trading above spot (contango), not below spot - **Option B & D**: These strategies don't exploit the price differential between spot and futures markets **Key Concept**: Futures and spot prices must converge at delivery due to arbitrage opportunities. When futures trade below spot, buying futures and shorting spot creates a guaranteed profit.
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A junior trader at a UK-based commodity trading company is considering implementing a trading strategy using futures. The trader notes that the Brent crude oil futures for delivery next month are currently trading below the spot price. Assuming no transaction or delivery costs, which of the following strategies would be expected to generate a profit for the trader?
A
Short the futures, buy the Brent crude at spot, and deliver against the futures at settlement.
B
Short the futures and deliver against the futures at settlement.
C
Buy the futures, short Brent crude at spot, and take delivery against the futures at settlement.
D
Buy the futures and take delivery against the futures at settlement.
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