Arbitrage fund is a type of mutual fund that leverages the price differential in the cash and derivatives market to generate returns. The returns are dependent on the volatility of the asset. These funds are hybrid in nature as they have the provision of investing a sizeable portion of the portfolio in debt markets.

Arbitrage funds buy stock in the cash market and simultaneously sell a contract for it on the futures market if the market is bullish on the stock. If the market is bearish, then arbitrage funds purchase the lower-priced futures contracts and sell shares on the cash market for the higher current price.

Arbitrage funds may also profit from trading stocks on different exchanges. For example, they might purchase a stock at 100 rs on the BSE and then immediately sell it at 100.15 on the NSE.

In India Arbitrage funds have gained popularity due to tax advantages they can offer compared to Debt Funds.