What is Spatial Arbitrage?
The primary goal of every investor in the financial market is to earn a hefty return on investment. Stocks, bonds, commodities, derivatives, etc., are some of the asset classes investors use to trade, diversify, and hedge. However, there are various trading techniques to utilize the profit margin at its highest. One such technique is Spatial arbitrage.
But to understand Spatial arbitrage, it is important to learn about Arbitrage in general.
What is Arbitrage?
Various assets are traded in high volume across different exchanges in India. However, due to market inefficiencies and differential demand-supply, the price of the asset classes may vary across platforms. For example, you may have noticed that the shares of a particular company have a different prices on the National Stock Exchange and the Bombay Stock Exchange. When this happens, investors see profit potential.
Arbitrage is the simultaneous buying and selling of any of the securities, such as stock, commodities, bonds, currencies, etc., in different markets to profit from the price difference. These investors, called arbitrageurs, research the price difference and buy the security from one market at a lower price and sell it in another market where the price is high.
There are types of Arbitrage, such as Merger Arbitrage, Regulatory Arbitrage, and more. One of the most widely used types is Spatial Arbitrage.
What is Spatial Arbitrage?
This is when an arbitrageur uses geographical factors to buy an asset from an area and sell it at a different place at a higher price. For example, if crude oil prices are low in Delhi, an arbitrageur can buy it there and sell it at a place such as Chennai if the prices of crude oil there are higher.
What are the three conditions for Arbitrage?
Arbitrage is possible under the following three conditions:
- The assets should be the same, which are trading in different markets. If the asset does not trade in both markets, arbitrage is not possible.
- Assets that are trading in various markets should have the same cash flow. For example, if a bond is Rs 10,000 in one market and Rs 9,500 in another but pays the same interest of 5%, there is an arbitrage opportunity.
- If an asset is trading at a discount from a predetermined future price about its risk-free interest rate, there is a possibility for arbitrage. For example, if a company is to be acquired at Rs 15 per share at a future date, but its shares are trading at Rs 10 today, arbitrage is possible under such a situation.
What are Arbitrage strategies?
Here are some of the Arbitrage strategies you can use to ensure you earn profits:
Arbitrage and its types have the power to increase your profits and diversity within your chosen asset class. As the market always presents some type of inefficiencies, you can research and buy cheap assets and sell where the prices are high. However, it is always wise to limit your risk exposure and ensure you buy assets smartly.
- Consult an experienced financial advisor such as IIFL to understand the process, legality, and taxability of Arbitrage.
- Learn and understand every type of Arbitrage before you choose your preferred technique.
- Perform extensive research before buying an asset and keep a potential buyer ready beforehand to sell the asset.
- It is wise not to buy multiple assets simultaneously and buy one only after you have sold the previous.
Frequently Asked Questions Expand All
Spatial Arbitrage takes geological factors into consideration where investors buy assets at a place where they are cheap and sell at a place where the prices are high. In this way, investors make profits because of the price difference.