Arbitrage opportunities appear here and there, all the time in the financial markets. Pure 100% risk-free stock market arbitrage opportunities are hard to spot, however it is essential to understand how the markets offer this opportunity, and then apply similar principles on other trades, where there’s very little risk, or there’s no risk at all!
In both cases, with the 100% risk-free arbitrage trades and the extremely low risk/low reward trades, a stock investor and/or option trader has to look beyond the obvious and uncover the real opportunity. Looking beyond the obvious is important, because we cannot tell by just looking at a bunch numerical data if there’s an arbitrage opportunity or not. Investing in the very short stock market cycles means a small return, but the setups occur so frequently, as frequently as 3 times a day, therefore a 5% investment, repeated over 3 times daily can become a large return investment.
Before we move to options and stocks, let’s see how arbitrage works in sporting events, such as horse racing, consider a horse race and the betting market around it:
By combining the best odds, from several different bookmakers, we have the following cases:
Can you figure out which of the two combinations of odds offers an opportunity for an arbitrage profit?
The fact is that combination 1 loses money, even with the best distribution possible you would always lose 11.6%. Combination 2 however does offer an arbitrage opportunity, and to be exact, it makes 11% of profit, no matter which horse wins the race. I did use a formula to figure out if there’s a profit margin or not, and I also need another formula to figure out how much money exactly I would have to bet on each selection, in order for my arbitrage equation to hold true.
Stock Market Arbitrage With Complete Protection
It’s similar with stocks and stock options, there are so many numerical data, that are beyond an easy calculation, let alone a simple observation. Arbitrage is not about fooling one option broker, is simply about exploiting the whole system of brokers, who collectively appear to you as a risk-less trading platform. That is, one trade’s risk is offset by another trade’s reward, both trades placed on the same underlying stock, at a different option broker or using a different kind of option trade!
Stock Arbitrage Strategy
Overbought – Oversold: One common stock market arbitrage strategy is to spot a market, such as two highly correlated stock indices, or actual stocks that every now and then fall out of sync. If one of the stocks rises too much while the other is lagging behind, it is almost certain that sooner or later they will fall back in synch with each other again! So the trader sells the overbought stock, while at the same time he buys the lagging stock. The outcome of this is that the profit made on the winning trade will exceed the loss made on the losing trade. Stock market investing professionals and traders do this all the time, sometimes these opportunities may last only few minutes to a few hours, but they have the experience and techniques to place their trades simultaneously, thereby making risk free money.
This stock market arbitrage strategy can be implemented using many instruments, but option traders do it differently, when they detect an overbought-oversold relationship between an option and the underlying stock itself! This once again is an overlooked profit opportunity, and it means instant risk-less profit to the trader. Short term investing in the stock market like this, makes approximately 2% to 5% profit on the capital used, for example $50 on a $1,000 capital commitment.
Stock Market Investing Strategies and Market Speculation by..
Scott Smith
Investing The Stock Market © 2008 – 2010
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