The main objective of every investor in the financial market is to obtain a significant return on their investment. Stocks, bonds, commodities, derivatives, etc. are among the asset classes that investors use to trade, diversify and hedge. However, there are various trading techniques to use the profit margin to its maximum. One such technique is spatial arbitration.
But to understand spatial arbitration, it’s important to learn about arbitration in general.
What is arbitration?
Various assets are traded in high volume on different exchanges in India. However, due to market inefficiencies and differential supply, the price of asset classes may vary from platform to platform. For example, you may have noticed that the shares of a particular company have a different price 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 one 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 lower-priced market and sell it in another high-priced market.
There are different types of arbitration, such as merger arbitration, regulatory arbitration, etc. Spatial arbitration is one of the most widely used types.
What is spatial arbitration?
This is when an arbitrageur uses geographic factors to buy an asset from one area 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 to a place like Chennai if crude oil prices are higher there.
What are the three conditions of arbitration?
Arbitration is possible under the following three conditions:
- The assets must be the same, which trade in different markets. If the asset does not trade in both markets, arbitrage is not possible.
- Assets that trade in different markets should have the same cash flow. For example, if a bond is worth Rs 10,000 in one market and Rs 9,500 in another but pays the same 5% interest, there is an opportunity for arbitrage.
- If an asset is trading at a discount to a predetermined future price from its risk-free interest rate, there is an opportunity for arbitrage. For example, if a company is to be acquired at Rs 15 per share at a future date, but its shares are trading at Rs 10 today, arbitrage is possible in such a situation.
What are the arbitrage strategies?
Here are some of the arbitrage strategies you can use to make sure you are making a profit:
- Consult with an experienced financial advisor such as IIFL to understand the process, legality and taxation of arbitration.
- Learn and understand each type of officiating before choosing your preferred technique.
- Do thorough research before buying an asset and keep a potential buyer ready in advance to sell the asset.
- It is wise not to buy multiple assets simultaneously and only buy one after selling the previous one.
Arbitrage and its types have the power to increase your profits and diversity within your chosen asset class. Since the market always exhibits some type of inefficiency, you can find and buy cheap assets and sell where the prices are high. However, it is always wise to limit your exposure to risk and make sure you buy assets wisely.
Q.1: Understanding spatial arbitration
Reply : Spatial arbitrage takes into account geological factors when investors buy assets where they are cheap and sell where prices are high. In this way, investors make a profit because of the price difference.