What is arbitrage?

Arbitrage is an opportunity to profit from a momentary difference in the market price on a stock that is traded in separate exchanges. The differences in price is caused by unadjusted currency exchange rate. A trader who tracks political unrest or other global variables can recognize a temporary undervaluation in the market price for a stock.

For example, stock for a company, “A”, that is open to being acquired trades on the NYSE (Exchange B) for 40 USD/share, but also trades daily on the DAX (Exchange C) for 33.40 EUR/share. A decision is reached between the boards of the two companies that the acquiring company, Company “M”, will add an 11% premium per share on the initial offer to complete the merger with “A.”

News is released (by law) simultaneously between the two countries. It’s morning in the US, and the end of the business day in Germany where a holiday also begins the next day. No one is at work. The stock for Company “A”, the acquired, has agreed to acquisition. Therefore, a US trader can buy that stock on the DAX cheaper and simultaneously sell it on the US market where the trades and market value are increasing rapidly. The trader will profit if the spread in US (sell)/EUR (buy) exchange rate is great enough at the simultaneous trades and the transaction fees do not absorb the profit.

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