ECONOMYFINANCES

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.

Thanks to the ubiquitousness of data and information, investing has become more complex than simply buying and selling assets. Investors can hedgetheir portfolios more effectively than ever to minimize losses. However, the practice of investing is undertaken in anticipation of positive returns. Thus, analysis and strategies must be used in order to better facilitate such an outcome.

Prior to adopting an investment strategy, an investor must decide which financial product suits his or her needs. In the UK, financial spread betting has become a popular leveraged product. Spread betting allows investors to take a position on whether the market will rise or fall without owning any of the underlying asset. A spread is defined as the difference between the bid and theask price of a security. Investors align with the bid price if they believe the market will rise and go with the ask if they believe it will fall.

Implementing strategies and analysis can help investors reduce their exposure to substantial losses. Arbitrage, in particular, has been used by financial spread bettors looking to beat the market. The practice, while generally lower-risk, does have risks and limitations that can result in losses for an investor.

SPREAD BETTING

Financial spread betting capitalizes on the speculative nature of investors. As a leveraged product, a small deposit gives investors access to large market exposure. Using leverage has significant benefits and risks: investors with small investment capital gain exposure to markets, indices, and funds that were previously inaccessible. The spread is given by the buy and sell prices from the market, and while movements in the market dictate profit and losses, an investor has no ownership of the underlying assets.

As the market moves in an investor’s favor, higher returns will be realized; on the other hand, as the market moves against an investor, she will incur greater losses. Successfully predicting the market relies heavily on chance, but implementing a strategy can help mitigate losses and potentially increase returns. Financial spread betting presents opportunities for investors to use arbitrage to take advantage of price differences for risk-less profits. (For more,

ARBITRAGE

In finance, arbitrage is the buying and selling of an asset in order to exploit price differences. Arbitrage opportunities arise when the prices of identical financial instruments vary in different markets or among different companies. As a result, the financial instrument can be bought low and sold high simultaneously. An arbitrage transaction takes advantage of these market inefficiencies to gain risk-free returns.

Many different types of arbitrage exist, allowing for the exploitation of differences in interest rates, currencies, bonds and stocks among other securities. While arbitrage is typically associated with risk-less profit, there are in fact risks associated with the practice, including execution, counterparty and liquidity risks. Failure to complete transactions smoothly can lead to significant losses for the arbitrageur. Likewise, counterparty and liquidity risks can come from the markets or a company’s failure to fulfill a transaction.

SPREAD BETTING ARBITRAGE

Due to widespread access of information and increased communication, opportunities for arbitrage in spread betting and other financial instruments have been limited. However, spread betting arbitrage can still occur when two companies take separate stances on the market while setting their own spreads.

At the expense of the market maker, an arbitrageur bets on spreads from two different companies. When the top end of a spread offered by one company is below the bottom end of another’s spread, the arbitrageur profits from the gap between the two. Simply put, the trader buys low from one company and sells high in another. Whether the market increases or decreases does not dictate the amount of returns.

THE BOTTOM LINE

Implementing strategies and analysis with financial instruments can help mitigate risk and increase potential returns. Arbitrage, in particular, lets investors exploit the difference in prices between two markets. Opportunities for arbitrage are limited as advancements in technology and inter-company communication have greatly decreasing price difference occurrences, making the practice an inconsistent means of gaining returns. Within spread betting specifically, arbitrage can occur when two companies offer different spreads on identical assets. Acting on arbitrage opportunities must be done quickly in order to avoid execution, counterparty and liquidity risks.

[Source : investopedia.com]

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