FX Market Watch
through. Obstacles may include either party’s inability to satisfy conditions of the merger, a failure to obtain the requisite shareholder approval, failure to receive antitrust and other regulatory clearances, or some other event which may change the target’s or the acquirer’s willingness to consummate the transaction. Such possibilities put the risk in the term risk arbitrage. Additional complications can arise in stock for stock mergers when the exchange ratio is not constant but changes with the price of the acquirer. Tese are called “collars” and arbitrageurs use options-based models to value deals with collars. In addition, the exchange ratio is commonly determined by taking the average of the acquirer’s closing price over a period of time (typically 10 trading days prior to close), during which time the arbitrageur would actively hedge his position in order to ensure the correct hedge ratio.ii
DIFFERENCE BETWEEN PURE ARBITRAGE AND SUBTLE ARBITRAGE
Pure arbitrage would be if you had in the same pair a price discrepancy where you could buy in one account, sell in another, and have a risk free profit of the discrepancy. This is known in all markets as pure arbitrage. The word ‘arbitrage’ however has expanded to mean more subtle forms of arbitrage such as statistical arb and triangular arb which while not pure arb, they employ a ‘mean reversion’ calculation that implies that no matter what happens, 99.9% of the time the market will revert
to the mean model. This is also the case in Risk arb, clearly not a form of pure arb, but still called arbitrage nonetheless.
ETHICAL ISSUES Some believe
that some forms of
arbitrage are somehow taking an unfair advantage of the market. While this is debatable, the larger issue is that due to perception by some, they may not allow a trader to withdraw his profits.
TRADING WITH ARB
Trading any type of arb model poses unique risks, challenges, and costs, not associated with traditional trading systems. Anyone who is considering ‘arbitrage’ should consider:
• It may require substantially more time investment • Many arb systems require a large investment in computer and network hardware • May require an extensive experience
54 FX TRADER MAGAZINE October - December 2011
in trading, I.T., and mathematics • As arb is always evolving, information obtained on the internet may be outdated • Large risk in some types of arb where you may not be able to withdraw your profits, or you may only have 1 leg filled causing the model to not be arb but an actual trade!
CONCLUSION
Arbitrage is a niche that while it can be profitable for extremely experienced and well funded traders, there are many unique ‘unknown unknowns’ when trading these types of systems. Even with a substantial time and money
investment, combined with
excellent research, it may not provide a guarantee for profit (which is implied assumption of arb systems).
Elite E Services i ii
http://www.investopedia.com http://www.ftmandate.com
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