Showing posts with label Stock Price Tool. Show all posts
Showing posts with label Stock Price Tool. Show all posts

Sunday, April 6, 2014

Arbitrage

Arbitrage is a trading strategy whereby a trader sells a security in one market and buys the same security in another market. Arbitrage is a term used to describe the purchase of a product which is then immediately sold to make a profit.

Arbitrage is popular in the stock market or as a means to make profit from goods being sold at differing prices in varying markets. A person who uses arbitrage is called an arbitrageur.

The person who conducts and takes advantage of arbitrage in stocks, commodities, interest rate bonds, derivative products, forex is know as an arbitrageur.

Arbitrage refers to the opportunity of taking advantage between the price difference between two different markets for that same stock or commodity.

Arbitrage is described as risk free because participants are not speculating on market movements. Instead, they bet on the mis-pricing of a share/asset that has happened between to related markets.

It is a highly technical field. Market’s mis-pricing is taken advantage by traders to make risk free gains.

Market arbitrageurs assume the risk that the price of a security in the offsetting market may rise unexpectedly and result in a loss. In theory, market arbitrage opportunities should only exist for a short time because security prices adjust according to forces of supply and demand.

Primarily, large institutional investors and hedge funds are the ones capable of profiting from market arbitrage opportunities. The spread between unequally priced securities is usually only a few cents, so very large amounts of capital are required in order to make substantial profits.

In simple terms one can understand by an example of a commodity selling in one market at price x and the same commodity selling in another market at price x + y. Now this y, is the difference between the two markets is the arbitrage available to the trader. The trade is carried simultaneously at both the markets so theoretically there is no risk. (This arbitrage should not be confused with the word arbitration, as arbitration is referred to solving of dispute between two or more parties. )

Arbitrage opportunities exists between different markets because there are different kind of players in the market, some might be speculators, others jobbers, some market-markets, and some might be arbitrageurs.

In India there are a good amount of Arbitrage opportunities between NCDEX, MCX in commodities.

In the Indian Stock Market, there are a good amount of Arbitrage opportunities between NSE, Cash and Future market and BSE, Cash and Future market.
    

Arbitrage Examples

  • Arbitrage exists in sports betting. When bookmakers offer various odds it opens the opportunity for betters to spread their cash out among different bookmakers in order take the best odds on each and cover any possible win or lose circumstance. This tactic often results in a small profit, but can be much more at times.
  • Exchange-traded funds, traded in the stock market, are also a means for an arbitrageur to make a profit. Participants in exchange-traded funds exchange shares in underlying securities as well as in the fund. This is different than the sale of other mutual funds since it does not promote shares being bought or sold with the fund sponsor. Prices are set by demand; and, when a drastic premium of the assets occurs, the underlying securities can be bought, converted and then sold in the open market. Similarly, when a drastic discount exists, the securities will be sold.

  • Supposing a stock on the NYSE is not in line with the stock's corresponding futures contract on OCX. The more inexpensive stock or contract can be purchased and then sold at a higher price on the other market.
  • Hedge funds can also use arbitrage to make a profit. Instead of purchasing and selling the same asset, a hedge fund might purchase and sell different derivatives, assets and securities that have similar characteristics. This practice lets the hedge fund "hedge" any big price differences between the two assets. 
  • The term arbitrage is also utilized by Google to describe those advertisers whose sites are filled with a lot of advertisements. They are banned from advertising on Google since the advertisers will make more money just from hosting the ads than Google would make from a user clicking only once. 
In summary, arbitrage basically means the exchanging of one thing for another to take advantage of price differences in two markets, hence earning a profit.

In most of the transactions of Arbitrage in stocks and commodities markets, the traders tries to square up the transaction by reversing both his trades and he pockets the difference in this way.

In any transaction, 100% risk can never be removed but the risk is highly reduced in an arbitrage transaction because generally at the end of the settlement, the spot and the future price have to converge and that is when an arbitrageur can quit his positions without any loss.