Arbitrage

Arbitrage is the simultaneous purchase and sale of the same (or an economically equivalent) asset on different venues or in different instruments in order to capture the price difference. What sets it apart from ordinary speculation is that the outcome does not depend on where the market goes next: the offsetting positions cancel each other out, and the profit is determined by the size of the discrepancy at the moment it is closed.

The mechanism: why the discrepancy disappears

The arbitrageur buys where the asset is cheaper and sells where it is dearer, then either waits for the prices to converge or closes both legs of the trade at once. Their own trading is what pushes the prices together: demand lifts the cheap side and supply weighs on the expensive one. That is why discrepancies on an organised market are short-lived — they are picked off by whoever spots them first.

The trade only makes sense when the difference covers the costs: the spread between the best bid and the best ask, the broker's commission and the infrastructure fees for custody and settlement. Hence the key condition — high liquidity: there must be enough volume to absorb both legs of the trade without moving the quotes. The classic sources of discrepancies are the price of a futures contract versus its underlying asset, the same security on different trading venues, and a fund unit versus the basket of assets it holds.

An example from market data

Arbitrage is not possible everywhere, only in securities where an order is filled instantly and at the displayed price. A practical guide is the leaders by turnover on the exchange:

In securities like these, discrepancies are captured by algorithms rather than by a manual trader. Outside the top of the turnover table, a price gap may look large precisely because a trade of the required size cannot be put together there.

Where the term is misunderstood

The main misuse is to call any bet on prices converging an arbitrage. Buying historically related securities in the expectation that the spread between them will revert to its usual level is statistical arbitrage, and it does carry risk: the relationship may break down. The second setting in which the term loses its meaning is a market under stress: discrepancies widen, but both legs cannot be executed at the quoted prices, and the heightened volatility turns an unclosed leg into a directional bet. And separately: in Russian, the same word more often refers to the commercial court — a meaning that has nothing to do with market arbitrage.