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Edited on Thu Jun-10-04 01:04 AM by Lucky Luciano
here is the deal....Arbitrage is a transaction that should theoretically create a guaranteed profit. Example:
Say gold is 375/oz in Hong Kong and 378 in London...if you can buy it in HK and flip it in London quickly then you lock in a guaranteed profit.
Another example...Say company ABCD buys company WXYZ where ABCD is priced at 100 and WXYZ is priced at 75....say the offer to WXYZ is one for one on shares. In theory this should increase the price of WXYZ to 100, but it does not. It often will go to 93 or something because it usually takes a long time for the deal to close (Technically this is not a risk free thing given that the deal could fall apart eventually, but let us assume this does not happen). Assume ABCD stays at 100. That means that there should be $7/share available to lock in for profit if you sell ABCD short and buy WXYZ long at 93. As the day for closing approaches, you will see the prices come closer and closer until they are in unison and you will have locked in the guaranteed $7/share from the arbitrage on closing day.
If you know anything about options:
Let us say that stock ABCD is priced at 75. Let us say that you have some ABCD call options with a strike price of 65. Since the options are in the money by 10 points, it should guarantee that one option contract is worht AT LEAST $1,000 (10 X 100 shares). Teh call option gives you the right to purchase ABCD at 65, so if the stock is currently at 75, then it makes sense that the option should be worth AT LEAST 10, but if for some reason it is selling for 9.90, then a savvy investor with a lot of money to avoid being eaten by commissions (most likely the options specialist in the trading pit who sees these brief and rare moments and can act immediately) will exercise as many options as they can get their hands on until the price comes to a more sensible level - so he would be locking in $.10 per share and this would give him $100 per contract...if he can get a hold of 100 contracts and exercise them, then he locks in $10,000 for himself - another example of arbitrage. I saw this happen with a friend who was on the OTHER end of the calls and it pissed him, but that is the way it goes!
There are countless other examples.
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