Arbitrage

Arbitrage/scalping is one of the oldest trading strategies in existence. In very simple terms, arbitrage is taking advantage of different buy and sell prices to lock in a guaranteed profit by trading both almost instantly. Can this strategy be used with binary options? Read on to find out

What Is Arbitrage?

Arbitrage, or ‘scalping’, is a classic trading strategy that has been around for hundreds of years. Simply put, it is the technique of buying an asset in place A and immediately selling it at a higher price in place B. The art is in identifying price disparity across markets and market makers.

Example Arbitrage Trade

Assume that a stock is sold for £100 in London while at the same time a trader in New York offers £101 to buy it.

If you bought the stock for £100 and sold it for £101, you would make a profit of £1. That is not a lot, but because both trades happen simultaneously, there is no risk.

The profit is guaranteed, which is why even a small profit is worth the investment.

Additionally, most arbitrage traders trade larger quantities to make up for the small profit of each individual quantity.

Since there is little to no risk, they can invest a higher percentage of their account balance in each single trade and net the same profit as a trader with a riskier strategy and a smaller investment.

Accounts

In order to spot these opportunities, traders need access to asset prices. In the binary markets, this can only be achieved by having trading accounts with multiple brokers.

The Arbitrage Process

1. Monitor a market or asset. Check values at a range of brokers or market makers.
2. Where values differ, and cover the costs of trading, an arbitrage opportunity has opened.
3. Open positions on both “Buy” and “Sell” prices. Set trade size to ensure profit.

Types Of Arbitrage

There are a range of arbitrage structures, or ways they can be used. Different markets require slightly different things in order to guarantee profit. Here, we explain some of these differences;

• Traditional – The usual, or most common form of arbitrage, is where an asset can be brought and sold at two prices. The trader can buy at the low price, sell at the higher price and – after trading costs – still lock in a risk free profit.
• Betting – Betting ‘arbing’ follows the same process. Rather than an asset value however, a sports bettor can back and lay the same selection. Assuming the prices are different enough, the trader can lay at a lower price than they back the selection at. With adequate stake sizing, a profit can be ensured regardless of the outcome of the sporting event.
• Forex – Traditional arbitrage is extremely unlikely on major forex pairs. However, it is possible to arb foreign exchange over the longer term by utilising interest rates. Constantly moving exchange rates mean this is not always zero risk however, and it is not something retail investors can achieve easily at low cost.
• Binary – In binary options, traders need volatile markets. This can lead to different payouts at different brokers. The ability to trade both sides of a digital option make arbitrage possible – at least one payout needs to be higher than 100%. In the absence of volatility, hugely one sided market sentiment is the only other driver that might trigger unusual payout figures.

Arbitrage Strategy

With binary options, an arbitrage strategy is very different from a classic arbitrage strategy. A classic arbitrage strategy is based on the characteristic that there are multiple large markets where you can buy and sell things and that you can sell in one market what you bought in another.

Binary options have no such central market, which is why you need to slightly modify the arbitrage strategy. While the arbitrage opportunities are limited compared to assets such as stocks, there are a few opportunities.

Here’s what you can do:

1. Compare different brokers: Every broker creates his own payouts. When you compare multiple brokers, you might find that you can invest in rising prices for an asset with one broker and in falling prices with another, and get a guaranteed payout of more than 100 percent –a guaranteed profit.
2. Compare similar stocks: Many news affect more than one stock. When a country’s central bank decides on what to do with the base rate, banks usually experience strong effects. By predicting rising prices for one bank and falling prices for another, you
3. Compare linked currencies: Currencies are always traded in pairs. When you take three currencies, you get three pairs. Often, you can find arbitrage opportunities where you can combine these pairs to effectively guarantee a combined payout of more than 100 percent.
4. Compare linked asset types: The relationship between the U.S. Dollar and oil/gold is often inverse. When the Dollar rises, oil falls. This relationship, too, offers arbitrage opportunities. The best opportunity for this type of trades is during times with high volatility, for example right after the release of significant news.

Risks Associated With Arbitrage

One key point that makes arbitrage chances so rare, is the cost of trading.

Generally, traders can buy and sell the same asset anytime they want – but it would result in a small loss. There is normally a spread, or trading margin, to make up.

If an asset is brought and sold, the costs of trading will mean a small loss is made. This is true even if the asset was brought and sold at the same price.

Any arbitrage formula or calculation then, must include these costs of trading. Failure to do so will guarantee a loss, rather than a profit.

Another risk is that of changing prices. Any difference in pricing is likely to be very quickly corrected. If these corrections happen before both sides of the trade have been placed, then the chance for locked in profit disappears. Where trades are being placed across different brokers or trading platforms, this risk is high.

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Trading Software

Brokers with comparable asset prices: