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What is Arbitrage?
- Thread starter trader924
- Start date
Can be defined several ways, for different applications. One application for derivatives goes as follows......When I am bidding for put options and get some, I will instantaneously "arb" or "flash" a order into the futures pit to buy futures to maintain a position which will not be affected by the immediate direction of the option or the future...Hope this helps
Yes "arbs" and "arbing" is the same as arbitrage, which in a nutshell is simultaneously buying and selling like securities with the goal of making a riskless profit.
so far so good...the idea is that the arb, in arbing, is part of the process of correcting price discrepancies.
A simple example is the differential between the spoo futures and the actual basket of 500 stocks. When the price of one deviates from its theoretical value, the arb will buy the low side and sell the high side. This is one form of arbitrage.
Taking advantage of price discrepancies of the same instrument on different exchanges is another form.
On Don's threads, the guys are arbing the theoretical value of a stock based on the what the futures say about stock prices on the open. They figure a fair value for a stock, and sell it if it opens higher or buy it if it opens lower. Do I have that right, guys?
A simple example is the differential between the spoo futures and the actual basket of 500 stocks. When the price of one deviates from its theoretical value, the arb will buy the low side and sell the high side. This is one form of arbitrage.
Taking advantage of price discrepancies of the same instrument on different exchanges is another form.
On Don's threads, the guys are arbing the theoretical value of a stock based on the what the futures say about stock prices on the open. They figure a fair value for a stock, and sell it if it opens higher or buy it if it opens lower. Do I have that right, guys?
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"Yes "arbs" and "arbing" is the same as arbitrage, which in a nutshell is simultaneously buying and selling like securities with the goal of making a riskless profit."
So you would go long and short simultaneously? Sorry if this is a stupid question. As far as riskless profits, I see some trade logs where the trader buys and shorts simultaneously then holds the position that is profitable and closes the losing position early. Is this arbitrage?
So you would go long and short simultaneously? Sorry if this is a stupid question. As far as riskless profits, I see some trade logs where the trader buys and shorts simultaneously then holds the position that is profitable and closes the losing position early. Is this arbitrage?
Trader,
Other than to reiterate what has been posted, there are two types of arbitrage. One is "riskless" and the other is risk.
Riskless arbitrage would be a play on price discrepancies that exist in markets. The most common being the imbalance between the price of a futures contract and the under lying assets. So you could sell the overvalued asset and buy the undervalued asset and wait for the "spread" to close. You may want to consult "When Genius Failed" the Long Term Capital Management Story to see what happens when spreads diverge and you are maxed on leverage. I will add that this could involve buying the same asset on one market and simultaneously selling it on another market. X is offered at 5 in London, and bid for 5.25 in Paris. Hence a risk free profit since these are the SAME asset.
Risk arbitrage would fall into the category of playing the spread on similar assets. For instance company X buys company Y. The two assets should trade in tandem. So you would sell X and buy Y and wait for the spread to close. But when a merger or correlation is broken, the spread will diverge. You may want to look at what happened when the GE / HON merger was blocked.
I have been working this into my trading more and more, and what I try to do is take the position off at one time. Now that can mean some things that intuitively suck. For instance I sold my long on Friday and bought back my hedge at close to the high for the day. At the end of the day, I reversed the position and bought my hedge long, for about $100 less than what I covered for. But, the purpose of the hedge in my opinion is to hedge and not be a piggy piggy. When you press, you can end up with less.
Other than to reiterate what has been posted, there are two types of arbitrage. One is "riskless" and the other is risk.
Riskless arbitrage would be a play on price discrepancies that exist in markets. The most common being the imbalance between the price of a futures contract and the under lying assets. So you could sell the overvalued asset and buy the undervalued asset and wait for the "spread" to close. You may want to consult "When Genius Failed" the Long Term Capital Management Story to see what happens when spreads diverge and you are maxed on leverage. I will add that this could involve buying the same asset on one market and simultaneously selling it on another market. X is offered at 5 in London, and bid for 5.25 in Paris. Hence a risk free profit since these are the SAME asset.
Risk arbitrage would fall into the category of playing the spread on similar assets. For instance company X buys company Y. The two assets should trade in tandem. So you would sell X and buy Y and wait for the spread to close. But when a merger or correlation is broken, the spread will diverge. You may want to look at what happened when the GE / HON merger was blocked.
I have been working this into my trading more and more, and what I try to do is take the position off at one time. Now that can mean some things that intuitively suck. For instance I sold my long on Friday and bought back my hedge at close to the high for the day. At the end of the day, I reversed the position and bought my hedge long, for about $100 less than what I covered for. But, the purpose of the hedge in my opinion is to hedge and not be a piggy piggy. When you press, you can end up with less.