What is Arbitrage?
Arbitrage is when an asset is purchased and sold at the same time in two different markets in order to pocket the tiny differences in the assets listed price from each market.
Understanding the Different Opportunities of Arbitrage
Arbitrage is the exploitation of momentary variations in the value of an identical or similar pair in different markets or different forms and takes advantage of the unavoidable inefficiencies in the markets.
Arbitrage can be done whenever there is any stock, commodity or currency that can be purchased in one market at a certain price and sold at the same time in another market for a higher price. For a trader, this creates a risk free opportunity for profit.
It is rare however, as advancements in technology have made it almost impossible to profit from pricing errors in the market. Therefore, most traders will have computerised trading systems set up to be able to monitor fluctuations in similar financial markets.
For a swap transaction, when a trader is buying or selling a forex pair, in actuality, they are borrowing a currency in order to lend in a different currency, therefore that difference between the interest rates of the two countries result in either a positive or negative value for the swap. This is also only available for retail traders.
This means that when the value is positive, the traders account will be credited, or in other words they are borrowing a low interest currency and lending a high interest rate one. One the other hand, if the value is negative, their account will be debited or, they are borrowing a higher interest rate currency while lending a lower rate interest one.
In the case where a broker allows a customer to open a swap free trading account, a trader can profit off forex positions without having to pay swap rates. A situation for this to occur can be when a trader is able to take a positive swap position with a broker that pays swap and the opposite position with a broker that does not credit or debit swap, which allows the trader to cancel the market risk involved.
In the situation mentioned above, a retail traders swap paying account will accumulate a net market loss, and their swap free account will have an accumulated net profit. If the trader wanted to reopen their positions, they would have to transfer money between the two accounts and incur transfer costs. However, these costs are avoidable if they are able to maintain a good margin for both accounts to be able to withstand the draw downs.
Arbitraging FX Futures Against Spot FX
The spot price of a pair is the current quote for immediate purchase, payment and delivery of that pair, while the futures price is the offer for a financial transaction that will occur at a later date. This presents an arbitrage strategy for traders called the spot-future arbitrage.
A spot-future arbitrage can occur when there is a price difference between spot and future prices in the market. In this scenario, a trader would be able to sell a futures contract that's trading at a premium, and at the same time, buy the spot price equivalent quality. Therefore, the difference in price is the profit.
This occurs due to the difference of interest rates which allows currency futures to sell at a premium or discount rate. This is dependent on how wide the interest rate differential is between the two currencies involved.