Benefits of Arbitrage

What is Arbitrage?

Arbitrage is a strategy that investors use while trading where they purchase an asset in one market and sell the same in a different market or stock exchange. This investing strategy helps the investors generate profit through an asset’s varying prices in different markets. Big institutions, hedge funds, and professional traders take advantage of this investing strategy to generate profit in large volume. Arbitrage is a practice where traders take benefit of market inefficiency. The person exercising this strategy is called an “Arbitrageur”....

How Does Arbitrage Work?

1. Arbitrage trading exploits price inefficiencies in various markets. An investor can make a good amount of profit with no or very little risk by taking advantage of price differences between the two markets for the same asset....

Example of Arbitrage

1. For instance, shares of ABC company are listed on the National Stock Exchange (NSE) and New York Stock Exchange (NYSE). The share price on NSE is ₹350 and on NYSE it is listed at $40 per share. Assuming the USD/INR exchange is ₹80 per dollar then the share price of XYZ will be equal to ₹320. Now, the trader practising arbitrage would purchase shares of XYZ at ₹320 on NYSE and sell them at ₹350 on NSE. He will generate a profit of ₹30 per share. This was an example involving the stock exchanges of two different countries....

Types of Arbitrage

1. Pure Arbitrage: It is what is commonly known as ‘arbitrage’. Pure arbitrage is an investment strategy with minimum or no risk in which the investor takes advantage of market inefficiency. Here, the trader purchases the asset on one stock exchange where the price is lower and sells it on different exchanges where the price is higher. This occurs when an asset is being traded on different markets. The opportunities for pure arbitrage exist because market participants take time to gain and adapt to new information....

Benefits of Arbitrage

1. Low Risk: It is an investing strategy using which an investor can make a good amount of profit with no or very little risk by taking advantage of price differences between the two markets for the same asset....

Drawbacks of Arbitrage

1. Transaction Cost: There is a high transaction cost linked to buying and selling assets that people usually ignore. Further, taxes are also applied to the income generated through the selling of the asset. Both of these elements lower the profit or sometimes result in loss....

Conditions for Arbitrage

1. Asset Availability: In trading, the asset must be listed in two stock exchanges, which are to be considered for arbitrage trading. For instance, if a person is planning to purchase a share of ABC company on the National Stock Exchange and sell it on the Singapore Stock Exchange, he must make sure that the shares of ABC company are listed on both stock exchanges....

Trading with Arbitrage

Trading with arbitrage is mainly done by large institutions, hedge funds and professional traders, who take advantage of this investing strategy to generate profit in large volume. Arbitrage trading is a great opportunity to make a profit with very low risk. With the advancement of technology, traders can quickly buy and sell securities online which ultimately has improved the efficiency of the market. This has reduced the period of price difference of an asset and led to a lack of arbitrage opportunities. In India, there are two recognised stock exchanges are National Stock Exchange(NSE) and the Bombay Stock Exchange(BSE). The securities of the companies are listed in these two exchanges. However, the Securities Exchange Board of India(SEBI), the regulatory body of the secondary market, does not allow arbitrage trading. It means that traders can not purchase security from one market and sell it on the other on the same day. Hence, it is not easy to get involved in arbitrage trading in the Indian market....

Conclusion

Arbitrage is a condition where you can buy and sell the same asset simultaneously at different prices, resulting in a risk-free profit. With various advantages, it also has some downfalls. Trading with arbitrage is mainly done by large institutions. However, in real life, there are very less opportunities for arbitrating because of the enhanced technology and awareness of the loopholes. It is an investing strategy using which an investor can make a good amount of profit with no or very little risk. While practicing arbitrage, the availability of capital is a key aspect to generating more profit and exploiting the price inefficiency in a better way. Moreover, efficient utilisation of advanced technology, and ability to adapt to the dynamic conditions of the market. , as well as the use of analytical tools are also some of the essentials for generating high-profit margins....

Frequently Asked Questions(FAQs)

What is arbitrage?...