Arbitrage operations in stock markets

Arbitrage operations in stock markets

Author: staslabutis On: 21.07.2017

October 16, by Rajat Sharma 2 Comments. Arbitrage involves buying and selling the same asset simultaneously across two different markets to profit from the price difference. The big point to note is — inequality of price across markets provides arbitrageurs an opportunity to profit.

This price differential is a consequence of the natural process of buying and selling a stock or its derivative which may be available for trading on more than one market. Below I will discuss arbitrage opportunity across cash-future and in the option market.

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Reliance Communications R-Com shares are trading at Rs. Arbitrageurs will sell the stock in the futures market and buy an equal quantity of the stock in the cash market to lock in a difference of Rs. As a rule, upon expiry both the futures and cash price of a particular security converges. At this time, they will offset the position i.

It does not matter what the price of R-Com, may be upon expiry. Whether the price of R-Com is Rs 60 or Rs. In other words, he unwinds both his position.

arbitrage operations in stock markets

The maximum profit he could make by doing this is Rs. An arbitrageur will not always wait for the expiry of the contract or the settlement of the transaction. They may reverse, i. Chart below shows 3 different closing prices on expiry and how the gain is made: Remember, arbitrage makes sense only if you are able to make a higher profit than what you could make in other risk free opportunities.

If you take bank FD rate of 8. There are potentially hundreds of arbitrage opportunities in the options market which is why it attracts some of the sharpest minds and gives rise to so much new business activity. The underlying principle in all cases is to profit from the price disparity of option premiums, either across calls and puts of same or different strike prices; or across calls or puts with different strike prices.

Here again, unless the return you make is higher than the risk free rate, it is not an attractive option. A very popular strategy which I have discussed in our section on option trading strategies is where a long term investor is happy to sell a stock upon achieving a certain strike price. In such a scenario, he could sell write call options at that price and profit to the extent of the premium he receives.

In case the stock closes above the strike price, his profit will be limited to the premium. Ideally, he would hope that the stock closes just a little below the strike price. Let me explain with an example:. Reliance Industries is trading at Rs.

arbitrage operations in stock markets

You buy shares. You sell 4 lots RIL lot size — shares and net Rs. If the stock rises above , the call buyer will exercise his option and you will have to pay to the extent it rises above Rs. You can sell your stock and pay him J No matter how much it rises, since you have actual delivery position, you will be able to pay him. However, your upside will be capped to a maximum of Rs.

In case RIL falls from here, you would have reduced your average buy price by Rs. You can assume that you purchased shares for Rs.

Arbitrage Opportunity in Stock Markets

Next month, you can again collect call option premium and basically repeat this until when the stock suddenly jumps in a few days at which time you will have to exit with whatever little profit you make. Still you can earn from such cross market arbitrage opportunities if you find price difference on the two exchanges and you have actual delivery position in the underlying stock, to sell in one market as you buy in the other.

arbitrage operations in stock markets

This is possible only if you had the underlying stock in your holding from an earlier period of time, i. LOOKING FOR A FINANCIAL ADVISOR? WANT TO OPEN A TRADING ACCOUNT? FILL IN YOUR DETAILS BELOW. To Discuss Investment options across Stocks, Mutual Fund and PMS Schemes. Leave your Whatsapp message or Email at rajat sanasecurities. Option Strategy , Trading Tagged: Rajat Sharma is a well known stock market analyst and commentator.

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