Arbitrage trading occurs on all markets
every day that the exchange is open for trading, most of us just aren't aware
of these unique opportunities. Arbitrage opportunities are not available for
long, often only seconds but they allow the trader the opportunity, if speaking
of arbitrage in its purest form, to make a riskless profit by simultaneously
buying and selling the same or similar securities. Identifying these
opportunities in order to take advantage of them is the challenge.
Arbitrage trading opportunities become
available when the price of a security is different from the same or similar
security on another market. For example a stock may react to news resulting in
a price increase per share, at the same time there may be call options
available on the stock that have not been repriced yet. The trader would sell
the higher priced stock and purchase the call options, this allows the trader a
risk free profit of the amount between the sell price and the buy price.
Another example of a common arbitrage
trading opportunity is between the S&P 500 stocks and S&P 500 futures.
Often there is a disparity in the price between the two as the stocks trade on
the NASDAQ and NYSE while the futures trade on the CME. If the S&P500
stocks get ahead of the futures the trader will sell the stocks and buy the
futures, again making a risk free profit. These opportunities usually only last
a few seconds.
In order for one of the above two
arbitrage trading opportunities above to become available one of the below
conditions must be violated:
1. The same security must trade at the
same price on all markets.
2. Two securities with identical cash
flows must trade at the same price.
3. A security with a known price in the
future (via a futures contract) must trade today at that price discounted by
the risk-free rate.
As you can see arbitrage trading
opportunities are quite straight forward but discovering an opportunity is much
more complex. This often results in riskless arbitrage not being available to the
average retail investor. Also although these strategies seem easy to identify
in theory executing them in the real world is very difficult. Many institutions
possess complex and expensive trading software that allows them to take
advantage of these types of opportunities. There are however several risk
arbitrage opportunities that offer the trader the potential for profit. Good
luck in your pursuit for risk free profits!
Author:
Andi Sachs
