Arbitrage opportunities exist when the prices of similar assets are set at different levels. This opportunity allows an investor to achieve a profit with zero risk and limited funds by simply selling the asset in the overpriced market and simultaneously buying it in the cheaper market.

This buying and selling of the asset will push the cheaper asset's price up and the higher asset price down. This process will continue until the asset price is equal in both markets.

Achieving this equilibrium through buying and selling is referred to as the law of one price. This law may look like it has been violated at times, but this usually is usually not the case once you factor in financing or delivery costs associated with the different markets.

  • For example, on exchange A IBN is trading at $25 and on exchange B IBN is trading at $30 dollars. If you buy IBN on exchange A and simultaneously sell it on exchange B, you can net a profit of $5 with out any risk or any outlay of cash.
  • As people continue to buy on exchange A, the price of IBN will increase and all of the selling of IBN on exchange B will force the price down until equilibrium has been reached. This is how arbitrage works to make the marketplace efficient.


Additional information about arbitrage and its theories:

  • Theoretically, the large number of market participants combined with real-time price-setting mechanisms eliminates the opportunity to generate risk-free profits.
  • This leads to an important question: If there are no arbitrage opportunities (i.e. opportunities to earn a risk-free profit), why does the industry survive? One reason is that individual investors may have different views on how, why and to what degree market prices are off kilter. Also, investors are reluctant to believe that there are no arbitrage opportunities and so they spend a good deal of time watching price movements, ferreting out inconsistencies and trading on those they perceive to exist. The process itself ensures that any potential arbitrage opportunities will be quickly discovered and eliminated. If investors believed there were no arbitrage opportunities and were no longer vigilant about identifying and exploiting price differentials, the lack of continuous oversight might, in itself, lead to arbitrage opportunities In other words, disbelief concerning the absence of arbitrage opportunities is required to maintain its legitimacy as a principle.
  • Relatively efficient markets have either no arbitrage opportunities or the market participants quickly remove them. The opportunity can occur, but only through chance and it would be considered an abnormal return
Forward Markets and Contracts: Settlement Procedures

Related Articles
  1. Trading

    Trading The Odds With Arbitrage

    Profiting from arbitrage is not only for market makers - retail traders can find opportunity in risk arbitrage.
  2. Investing

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  3. Investing

    Arbitrage Opportunities in Spread Betting

    While the opportunities are few and far between, investors may use arbitrage to take advantage of price differences in financial spread betting.
  4. Trading

    Make Money Through Risk Arbitrage Trading

    Risk arbitrage provides a valuable trading strategy for M&A or other corporate actions eligible stocks. Investopedia explains how it works.
  5. Investing

    Arbitrage Squeezes Profit From Market Inefficiency

    This influential strategy capitalizes on the relationship between price and liquidity.
  6. Investing

    3 Mutual Funds Focusing on Arbitrage Profits (MERFX, ARBFX)

    Get details on three of the most popular mutual funds for investors interested in arbitrage trading.
  7. Tech

    Looking for Bitcoin Arbitrage Opportunities? Read This First

    Bitcoin arbitrage involves buying relatively undervalued bitcoins and selling them at exchanges where they are relatively overvalued in order to make a profit.
  8. Investing

    Conversion Arbitrage

    This stock/options combination helps traders take advantage of market mispricing. Find out how.
  9. Trading

    Arbitrage

    Learn more about this trade that profits from price differences between financal instruments and markets.
Frequently Asked Questions
  1. Why Do Most of My Mortgage Payments Start Out as Interest?

    Fear not: Over the life of the mortgage, the portions of interest to principal will change.
  2. What is the difference between secured and unsecured debts?

    The differences between secured and unsecured debt, and how banks buffer risks associated with each type of loan through ...
  3. How Many Times has Warren Buffett Been Married?

    Warren Buffett has been married twice in his life, but the circumstances surrounding the marriages were unconventional.
  4. What's the smallest number of shares of stock that I can buy?

    Many people would say the smallest number of shares an investor can purchase is one, but the real answer is not as straightforward. ...
Trading Center