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Glossary

Arbitrage

Through arbitrage, market participants can make profits without risk exposure. Arbitrage can occur when different prices are quoted for the same security at a given point in time, either at separate stock exchanges, or in the cash and futures markets.

If the price of a given security varies from one stock exchange to another, market participants will exploit these differences by simultaneously purchasing the security at the exchange where it is cheaper (Exchange A) and selling it on the exchange where it is more expensive (Exchange B). The price at Exchange A will rise owing to the increased demand for the security, while at Exchange B, the price will drop as a result of the increase in supply. Thus, arbitrage enhances the efficiency of the market by equalizing the prices of the same security at different exchanges. In so-called cash-futures arbitrage, participants exploit the discrepancy between the prices of a security in the cash market and in the futures market. For example, an arbitrageur will buy a stock option that expires the same day in the hope of selling it on the cash market at a price which is higher than the exercise price.

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