What Is Arbitrage in trading? 

Arbitrage is an investment strategy in which an investor simultaneously buys and sells an asset in different markets to take advantage of a price difference and generate a profit. While price differences are typically small and short-lived, the returns can be impressive when multiplied by a large volume. Arbitrage is commonly leveraged by hedge funds and other sophisticated investors.

There are several types of arbitrage, including pure arbitrage, merger arbitrage, and convertible arbitrage. Global macro is another investment strategy related to arbitrage, but it’s considered a different approach because it refers to investing in economic changes between countries.

In the world of alternative investments, there are several strategies and tactics you can employ. These strategies often differ from the typical “buy and hold” tactics leveraged by most long-term stock and bond investors—and are usually more complicated.

Arbitrage is one alternative investment strategy that can prove exceptionally profitable when leveraged by a sophisticated investor. It also carries risks you must consider. To effectively include arbitrage in your alternative investment strategy, it’s critical to understand the nuances and risks involved.

Here's an overview of arbitrage, including a look at three types you should know: 

1: pure arbitrage, 

2:merger arbitrage

3:convertible arbitrage.

Pure arbitrage :

refers to the investment strategy above, in which an investor simultaneously buys and sells a security in different markets to take advantage of differences in price. As such, the terms “arbitrage” and “pure arbitrage” are often used interchangeably.

Many investments can be bought and sold in several markets. Whenever an asset is traded in multiple markets, it’s possible prices will temporarily fall out of sync. It’s when this price difference exists that pure arbitrage becomes possible.

Merger arbitrage, also called risk arbitrage, is a type of arbitrage related to merging entities, such as two publicly traded businesses.

Generally speaking, a merger consists of two parties: the acquiring company and its target. If the target company is a publicly traded entity, then the acquiring company must purchase the outstanding share of said company. In most cases, this is at a premium to what the stock is trading for at the time of the announcement, leading to a profit for shareholders. As the deal becomes public, traders looking to profit from the deal purchase the target company’s stock—driving it closer to the announced deal price.

Convertible arbitrage:

 is a form of arbitrage related to convertible bonds, also called convertible notes or convertible debt.

A convertible bond:

 is, at its heart, just like any other bond: It’s a form of corporate debt that yields interest payments to the bondholder. The primary difference between a convertible bond and a traditional bond is that, with a convertible bond, the bondholder has the option to convert it into shares of the underlying company at a later date, often at a discounted rate. Companies issue convertible bonds because doing so allows them to offer lower interest payments.

NOTE!! 

Arbitrage strategy can be an effective tool for investors seeking low-risk yields. Because yield is often small, it requires high volumes to realize the benefits of arbitrage and generate enough profit to overcome transaction fees. For this reason, arbitrage is generally not a strategy individual investors can leverage for themselves. It is, however, often used by hedge funds and other institutional investors that are capable of high volumes.

While effective, arbitrage is just one tool among many when it comes to alternative investments. If you’re considering a career in alternative investments, it’s important to understand all of the potential strategies you can leverage for your clients, including possible arbitrage opportunities. Taking an online course, such as Alternative Investments, is an excellent means of gaining the knowledge you need to be successful.