What is Spatial Arbitrage? | IIFL Knowledge Center

The main objective of every investor in the financial market is to obtain a high return on investment. Stocks, bonds, commodities, derivatives, etc. are among the asset classes that investors use to trade, diversify and hedge. However, there are different trading techniques to use the profit margin to its maximum. One such technique is spatial arbitrage.

But to understand spatial arbitrage, it’s important to learn about arbitrage in general.

What is Arbitration?

Various assets are traded in high volume on different exchanges in India. However, due to market inefficiencies and the gap between supply and demand, the price of asset classes may vary from platform to platform. For example, you may have noticed that shares of a particular company have different prices on the National Stock Exchange and the Bombay Stock Exchange. When this happens, investors see the potential for profit.

Arbitrage is the simultaneous buying and selling of any of the securities, such as stocks, commodities, bonds, currencies, etc., in different markets to take advantage of the price difference. These investors, called arbitrageurs, look for the price difference and buy the security in one market at a lower price and resell it in another market where the price is high.

There are different types of arbitration, such as merger arbitration, regulatory arbitration, etc. One of the most widely used types is spatial arbitration.

What is Spatial Arbitrage?

It is when an arbitrageur uses geographic factors to buy an asset in one region and sell it in a different location at a higher price. For example, if crude oil prices are low in Delhi, an arbitrageur can buy it there and sell it in a place like Chennai if crude oil prices are higher there.

What are the three conditions for arbitration?

Arbitration is possible under the following three conditions:

  • The assets must be the same, trading in different markets. If the asset is not trading in both markets, arbitrage is not possible.
  • Assets that trade in different markets must have the same cash flow. For example, if a bond costs Rs 10,000 in one market and Rs 9,500 in another but pays the same 5% interest, there is an arbitrage opportunity.
  • If an asset is trading at a discount to a predetermined future price relative to its risk-free interest rate, there is a possibility of arbitrage. For example, if a company is to be acquired at Rs 15 per share at a later date, but its shares are trading at Rs 10 today, arbitrage is possible in such a situation.

What are arbitrage strategies?

Here are some of the arbitrage strategies you can use to ensure you make a profit:

Arbitrage and its types have the power to increase your profits and diversity within your chosen asset class. As the market always exhibits some type of inefficiency, you can seek out and buy cheap assets and sell where the prices are high. However, it is always wise to limit your risk exposure and make sure you buy assets wisely.

  • Consult with an experienced financial advisor such as IIFL to understand the process, legality and taxation of arbitration.
  • Learn and understand each type of arbitration before choosing your preferred technique.
  • Do thorough research before buying an asset and keep a potential buyer ready to sell the asset.
  • It is wise not to buy multiple assets simultaneously and only buy one after selling the previous one.

About Chris McCarter

Check Also

Crypto Arbitrage in 2022: What You Need to Know

Cryptocurrencies have positioned themselves as a powerful innovation. And over the years, many profitable opportunities …