Market Watch
terminal price was guaranteed, so an EA could hammer the MT4 server for requests for new prices, and in some cases, the server price was different than the terminal price, thus allowing for risk free arb. Tis was however not ‘real’ trading.
MARKET ARB INFORMATION ARB
This is the least defined, and the highest
probability securities, but of success
of any type of arb. Most have disregarded this strategy because of insider trading laws pertaining to
information
arb can take other forms in other markets that do not have insider trading laws. The most common example of information arb is in the movie Trading Places, when the Duke brothers attempt to learn the forecast of the Orange crop report before it’s released to the market. With information arb, a trader has a 99% guarantee of success, 1% leaving that it is always possible that information can change during that time.
In rare cases, market discrepancies will allow for arbitrage on a pure market basis. It is so rare in fact, it isn’t likely that a trader could base a strategy completely on this method. See the below snapshot of Currenex during NFP release:
RISK ARB
Risk arb, or merger arbitrage, is when a hedge fund bets on the price of a stock which will change in price in the event of a merger or acquisition. Tere is supposedly a calculable chance of the deal not going through, which can be built into the strategy in the form of out of the money options, to limit the risk in the event of a negative outcome. Risk arb is
an example of a type of arb that really isn’t arbitrage according to the traditional definition, but is used to describe the high probability that a stock price may go to a pre-defined level based on the proposed merger.
Two principal types of merger are possible: a cash merger, and a stock merger. In a cash merger, an acquirer proposes to purchase the shares of the target for a certain price in cash. Until the acquisition is completed, the stock of the target typically trades below the purchase price. An arbitrageur buys the stock of the target and makes a gain if the acquirer ultimately buys the stock.
In a stock for stock merger, the acquirer proposes to buy the target by exchanging its own stock for the stock of the target. An arbitrageur may then short sell the acquirer and buy the stock of the target. Tis process is called “setting a spread.” Aſter the merger is completed, the target’s stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. Te arbitrageur delivers the converted stock into his short position to complete the arbitrage.
Te most common example of information arb is in the movie Trading Places
If this strategy were risk-fee, many investors would immediately adopt it, and any possible gain for any investor would disappear. However, risk arises fom the possibility of deals failing to go
FX TRADER MAGAZINE October - December 2011 53
FX
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