A Word About "Arbitrage"...

bone said:
There's been some talk on and off again here on ET about Arbitrage. And from what I've seen, the term is frequently mangled.

Legitimate Arbitrage is as rare as hen's teeth - and disappears very quickly.

One example might be buying BTC on one exchange for $XYX and selling it two seconds later on another exchange for $XYZ + $20.

Usually what most people label as "arbitrage" is actually a highly correlated spread trade that someone is legging into and out of.

Even buying a physical commodity and selling the direct analog futures contract is not technically an arbitrage. And it isn't a direct arbitrage in reality. By definition an arbitrage is relatively risk-free and is exploiting a mismatch - usually along the lines of a communication lag or unequal and temporary market duplication typically with multiple marketplace locations.

In other words - very temporary market dislocations regarding the same product.

For example, buying an On-The-Run US Ten Year Note and selling the CBoT Ten Year Futures Contract has basis risk. The Repo market rates have been unusually volatile the past couple years.

Selling physical oil in Texas and buying the Nymex WTI Futures Contract has basis risk. Look at what happened to the May 2020 futures contract - the complete lack of storage compatible with the futures contract specifications and the amazing lack of demand from refineries led to the famous negative futures price.
More...

One of the most important premise for arbitrage is that the two different products have to be extremely similar to the point that they are completely interchangeable, e.g. buy/sell a cross exchange rate vs. buy/sell one direct exchange rate to the common currency and then buy/sell to the other direct exchange rate to the same common currency right away with no carrying cost to take advantage of any price differentials. The currencies are exactly the same and can be obviously used interchangeably. Any time when you introduce other costs and extra fees that's levied on one product but not the other like carrying costs, storage costs, you change the product itself and it reduces the arbitragibility between the two.
 
JSOP said:
One of the most important premise for arbitrage is that the two different products have to be extremely similar to the point that they are completely interchangeable, e.g. buy/sell a cross exchange rate vs. buy/sell one direct exchange rate to the common currency and then buy/sell to the other direct exchange rate to the same common currency right away with no carrying cost to take advantage of any price differentials. The currencies are exactly the same and can be obviously used interchangeably. Any time when you introduce other costs and extra fees that's levied on one product but not the other like carrying costs, storage costs, you change the product itself and it reduces the arbitragibility between the two.
More...

??
I know a self made billionaire who made his first 50 or so million in a commodity arbitrage that had nothing to do with fungibility - actually it was the opposite of fungibility.
 
newwurldmn said:
??
I know a self made billionaire who made his first 50 or so million in a commodity arbitrage that had nothing to do with fungibility - actually it was the opposite of fungibility.
More...

The price differential must be really large to be worth it then. Who's the billionaire? Is it somebody who's known?
 
newwurldmn said:
you wouldn’t know him as he’s one of the thousands of private company billionaires in the US that never get on the Forbes list.

but you would be shocked if I told you some of the assets he owned.
More...

What assets does he trade to arbitrage? Can you give a rough example of a trade that he does? Some assets may seem to be totally different but might have similarities and interchangeability that people don't see or realize that allows for profitable arbitrage opportunities.
 
Two "little guy" arbs that very much come to mind were: 1. A Bank Desk Trader in Chicago in the 90's who saw an arbitrage opportunity involving the CME Yen futures - he quit his Bank job and traded it himself. Made several million, then got clipped pretty good. Walked away with 4 million. and 2. A guy in the very early days of the CBOT Municipal Bond futures contract in the 80's. The original contract specification itself had a design 'flaw' that he took advantage of. He did really good and then stopped when the CBOT changed the contract specification.
 
bone said:
Two "little guy" arbs that very much come to mind were: 1. A Bank Desk Trader in Chicago in the 90's who saw an arbitrage opportunity involving the CME Yen futures - he quit his Bank job and traded it himself. Made several million, then got clipped pretty good. Walked away with 4 million. and 2. A guy in the very early days of the CBOT Municipal Bond futures contract in the 80's. The original contract specification itself had a design 'flaw' that he took advantage of. He did really good and then stopped when the CBOT changed the contract specification.
More...
Bone.. yes true many people use the word "Arbitrage" very loosely.. specially I have seen it used in the Indian trading market to explain futures calendar spreads :(.. having said that there used to be true Arbitrage possible in Indian market because unlike Say Singapore or Australia India (like US) has more than one active stock exchange and many stocks are dual listed... between BSE and NSE
any way weather it exists any more I don;t know + the state taxes are big Burdon there
Any way coming back to pure arb .. is it true that big boys can arb between 1SPx 5 ES contracts ( to be traded in after US hrs as SP then is available on Globex)
Using a very advance spreader ( perhaps more advance then TT or CQG)
I tried it on sim on TT and CQG ( a synthetic spread) in Sim even at retail level it showed profits but in reality what happens only exp people can say!
 
bone said:
Legitimate Arbitrage is as rare as hen's teeth - and disappears very quickly.
More...
There are plenty of true arbitrage opportunities across the market. These days they are usually small and require manual work (which is why they exist) but they are there for the taking by anyone who has the desire the get involved. For example, off the top of my head, I can name 4-5 products that have arbitrage opportunities and are too small for an institutional player to get involved in.

This said, most of apparent arbitrages are in reality statistical and involve risk in one or another way. If you don't think through the risks, frequently you find out about them the hard way.
 
You must log in or register to reply here.
Back
Top