Arbitrage, in its purest form, is defined as the purchase of securities in one market for immediate resale in another market in order to benefit from a price discrepancy. This translates into immediate profits without risk. For example, if the price of a security on the New York Stock Exchange is not synchronized with its corresponding futures contract on the Chicago Stock Exchange, a trader could simultaneously sell (short) the more expensive of the two and buy the other, thus benefiting from the difference.
Here we will leave you an example so you can understand. Let’s say Company A is currently trading at $10 per share. Company B, which wants to acquire Company A, decides to make a public tender offer on Company A for $15 per share. This means that all of Company A’s shares are now worth $15 per share, but are trading at only $10 per share. Let’s say that the first operations (generally not the retail operations) offer it up to $ 14 per share. Now, there’s still a difference of $1 per share – an opportunity for risk arbitrage.
As you’ll see, when the account is taken out, the percentage of profit starts to become noticeable. Of course, we’re talking about small amounts here. But many times, in big negotiations, we can see that the profits are abysmal. The percentage of profit that a person can earn through arbitration is going to depend on the ability of that buyer to resell the purchased shares. Profits can range from 20% to 100% of the total and if they are even more savage, they can exceed 100%.
Risk Arbitration: Mergers and Acquisitions Arbitration
The example of risk arbitrage we saw earlier demonstrates M&A arbitrage, and is probably the most common type of arbitrage. It usually involves locating an undervalued company that has been the subject of a takeover bid by another company. This offer would bring the company to its real or intrinsic value. If the merger is successful, everyone who took advantage of the opportunity will benefit handsomely; however, if the merger fails, the price may drop.
The key to success in this type of arbitrage is speed; traders using this method usually trade at Level II and have access to real-time market news. As soon as something is announced, they try to get into action before anyone else.
In CTrading, the trader has all the market information in real time, plus automatisms that help in the search for arbitrage opportunities between different markets, or even in a specific one using triangular arbitrage, thus helping in maximizing profits and ensuring losses in case of a market crash.
How can these opportunities be found?
Many will be wondering where they can find these affordable arbitration opportunities. The fact is that much of the information can be obtained with tools that are available to everyone. Brokers often offer newswire services that allow you to view the news as it is published.
Level II trading is also an option for individual traders and can give you an advantage. Finally, detection software can help locate undervalued securities. There are also several payment services that locate these arbitrage opportunities. Such services are especially useful for peer trading, which can involve a greater effort to find correlations between securities. Typically, these services will provide you with a daily or weekly spreadsheet describing opportunities that you can use to make a profit, so a tool such as CTrading is most helpful in finding opportunities and launching trades for peer arbitrage.
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