Taming the Bulls and Bears
Financial markets can prove to be the most promising option offering the richest of dividends provided that one is skilled enough to encash them…

By Jyoti K. Singh
Since the financial terms, arbitrage implies a procedure that takes advantage of the difference in price between two or more financial markets. It is all about striking a permutation of identical deals, which can take advantage of the imbalance, as in this trade, the market price difference only serves as the profit. In academic terms, an arbitrage signifies a transaction devoid of negative cash flow at a chronological state. In simpler words, this can be considered as a risk-free profit.

Considered to be risk-free in principle, statistical arbitrage, although connotes expected profit, yet losses may occur while putting it to practice. Some of the risks too are associated to this otherwise risk-free trade. Some of these risks are minor like price fluctuation that may affect the profit margins whereas the major ones include devaluation of currencies or derivatives. Using the word in academic sense, an arbitrage involves getting benefited from the price difference of an asset or indistinguishable cash flows. But in common terms, the practice refers to the differences between analogous assets as well.

People who get engaged in this trade of arbitrage are referred to as arbitrageurs who mainly trade in financial instruments only like currencies, bonds, stocks, commodities, and derivatives.

It is very hard to keep arbitrageurs out of financial markets just like puling compulsive chain-smokers out of public toilets. Most of us have come across the “No smoking” sign at the entry doors of public toilets yet compulsive smokers do manage somehow to slip into them at the very first opportunity irrespective of the guards even. On similar lines, arbitrageurs too create inroads in the financial markets to encash each arbitraging opportunity.

There are several institutions that have started teaching the arbitraging techniques to the students. From anyone to everyone like a student, a housewife, a businessman or even a retired professional can learn the trade in the duration of just three months. Recently, we had an opportunity to visit such an institute located at ITO and this is what Dhruv Das Munshi, the chief operating officer of the institute shared with Skills Ahead.

How would you explain arbitrage to a common man?
Arbitrage can be defined as a preferred method of earning a risk-free profit. But the trade prefers patient people only who can tolerantly wait, and watch. In theoretical terms, arbitrage takes place if the price of the same product or asset is different in two or more markets. An arbitrageur hence purchases a product or asset from one market at a lower price and simultaneously sells the same at a higher price in another market thereby earning a risk-free profit termed as ‘arbitrage’. This sort of arbitrage can take place in any market in respect of any commodity or product; however, the financial markets are one of the most preferred places for arbitrageurs. And that mainly happens because financial markets nowadays are interconnected through electronic means and one can concurrently accomplish trades in different markets. This way, they can take advantage of even the smallest of price differences even.

What all can be subjected to arbitrage?
In financial markets, almost all the financial instruments like currencies, bonds, derivatives, stocks or even variables such as interest rates, are even subjected to arbitrage. There exist various different kinds of the trade as well including currency arbitrage, interest rates arbitrage, labor arbitrage, regulatory arbitrage, cash and carry arbitrage, and so on.

What are the skills required for the trade?
Well, an arbitrageur must have an eagle’s eyesight coupled with a leopard’s quickness. And that is because modern technology has invented such sophisticated computer programs that even the microscopic discrepancies in prices are also noticed in a flash of second. And once such an opportunity props up, an arbitrageur is required to pounce at it before his/her fellow traders.

It is mainly because opportunities of arbitraging in financial markets in particular and in every market in general tend to evaporate very quickly for they transmit the seed of their own destruction.

What is the aim of your institute and its courses?
The aim of the Share Gurukul Arbitrage course is to confirm that the candidate possesses the professional knowledge, understanding and skills to pursue a career in arbitrage in the share market community. In particular, at the end of their training period qualified arbitrageurs are expected to have a good understanding of, and practical experience in arbitrage for their employers or their own trading systems. The syllabus is therefore designed primarily to ensure that students will gain the necessary skills to pursue their careers to a more advanced level in a professional manner.

What is meant by market convergence and how does it affect the trade?
Convergence starts the very minute arbitrageurs start to cash in on the price differences of markets. And the process as per livemint’s data includes, “The price of the asset in the market where it is priced low starts rising due to the buying activity of the arbitrageurs. Similarly, the price of an asset in the market where it is priced high starts falling due to the selling activity of the arbitrageurs. Finally, the prices of both the markets converge at a price that is called the arbitrage equilibrium price.”

Hence, arbitrageurs play a significant role in satisfying the widening gulf between demand and supply. Now, the quickness of this process solely rests over the efficiency of the concerned markets.

Can the modus operandi of arbitrage be called exotic?
No, there is nothing exotic about it. The process is logical rather. Let me explain again from the mint example only. I quote, “Suppose the future price of an asset is higher than its present price, you simply buy that asset now at a lower price and simultaneously sell the same in the futures market at a higher price. But this kind of arbitrage can work only if the purchase price of the asset at present, after adding the carrying cost, is less than the future price. Carrying cost includes cost of money in terms of interest and cost of preservation and storage, depending on the type of asset. This type of arbitrage, in technical terms, is known as “cash and carry arbitrage”.

There also exists an opposite version of the arbitraging trade. Known as “reverse cash and carry arbitrage, this implies selling any asset at a higher price at present for purchasing it simultaneously at a lower price from futures market. This method incurs dual benefits as one can gain from the differences between both spot and the future prices as well.

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