Arbitrage secrets for success
Arbitrage is the riskless purchase of one asset and simultaneous sale of another in such a way that you have no money invested and you are guaranteed a profit without risk.
The classic example if company A is buying company B, one share for one share. Company A’s stock is selling for $50 per share and company B’s stock is selling for $48. You sell short, Company A’s stock for whatever you can borrow and simultaneously buy Company B’s stock. You sell stock you do not own at $50 and use the money to buy the other stock at $48. You pocket the $2. When the company sends you the shares of company A in place of the shares of company B, you then pay back the short seller. You keep the $2. There is a mutual fund that actually does only this.
Another example, but one that should be riskless, but isn’t is Unilever. Unilever PLC and Unilever NV each own precisely half of the Unilever Group. Each one is half the company, it is really just two perfectly identical classes of shares with identical rights trading under two different tickers. They often trade far apart in price. You should be able to short one and buy the other, but this can go on for years and has been as much as a 35% difference before the prices converged. If you bought at a 10% difference you would lose 20% of your money before the market caught on, a few years later, of how big an error this was.
For it to be arbitrage, you must have no money of your own invested, there must be no risk at all, and you must make a profit. It is the proverbial free lunch. It can be done, it is hard to find the opportunities unless you spend a lot of time looking.
Arbitrage is the process of making profit from the price difference between two or more markets and a person who engages in arbitrage is called an arbitrageur. For example, an investor is trading simultaneously in NSE and BSE, for particular stock the price in BSE is lower than the trading price in NSE. He can then make profit from this price difference by opting for arbitrage. But arbitrage is not the simple act of buying one asset at one market and then selling it to another market at a later time when the price is higher. Rather to avoid market risks of price change you need to make sure that both the transactions at both the market are done simultaneously. To eliminate the risk of price fluctuation you need to make sure that both the transaction is completed even before the change in the price at any of the markets.
Arbitrage is typically associated with trading in financial instruments like bonds, stocks, derivatives, commodities and currencies. There are different types of arbitrage including Merger arbitrage, Convertible bond arbitrage, Regulatory arbitrage, Depository receipts, Municipal bond arbitrage, and Telecom arbitrage. There are some preconditions that are essential for a profitable arbitrage to take place. If any one of the following point is true for a given condition then it is assumed that a profitable arbitrage is possible,
The same asset does trade at the same price at different markets.
Two assets do not trade with the similar cash flow at the same market.
An asset with a known price of the future does not trade on a given day at the market that is discounted at the risk free interest rate.
If you want to maximize your profit from arbitrage you need to make sure that the asset you trade in are electronically traded across different markets. Only then you can effectively make the transactions at the real time and maximize your profit from the whole process. Arbitrage when done in an informative way and with proper stock market analysis can effectively increase your profit limit. To ensure that you get maximum return from the arbitrage consult your stock broker or financial advisor for the proper asset and for the best time.
Investopedia provides a clear definition of each kind of arbitrage, beginning with statistical arbitrage. Statistical arbitrage is very useful to investors, since it helps to keep stock prices in line with fair value. If used conservatively, it can be a relatively safe way to invest, since it allows traders to sell shares without negatively impacting the stock price. It is also a quick way to make a profit, since the trades are executed within seconds of each other.
Source:- Yahoo Answers