Understand Info On Equity Futures Arbitrage Trading

What is Arbitrage Trading?

Equity Futures Arbitrage Trading is to exploit the differences between two financial markets. It is sometimes known as Margin or Hedge Trading or a another variation of Pairs Trading.

A common arbitrage trading strategy is to trade the S&P500 against the S&P500 futures but it can be used as a strategy in Forex also Commodities trades or stock equity futures as well as in indexes.

Using the S&P500 also the S&P500 Futures example, a long trade on 1 whilst shorting the other could guarantee a profit if completed properly.

Fair Importance

The key to this type of trade is understanding Fair Value and how Futures are priced. A common misconception is that if say the S&P500 Futures are currently 6 pointers below the current cash price, all you would have to do is enter along on the Futures contract whilst shorting the Cash......

.....In actual fact this type of trade may be locking in a loss rather than a guaranteed profit......you have no manner of knowing whether the Futures are actually priced at a premium or are discount compared to the cash markets, without first calculating its Fair Importance.

Arbitrage Trading

Arbitrage trading can be done profitably but the margins on the previous example are likely to only be fractions of a location plus last meant for only a short time until the natural buying and selling forces in the market force prices into realignment.

Arbitrage trading related instruments can offer a guaranteed return on an investment but as a rule the margins involved in these trades are so tight that it is not a practical trading strategy for most traders as spreads are just too wide as well as perform not have the means of trading speedy enough to take advantage of the opportunities as they arise.

Pairs Trading

What most traders refer to as Pairs trading is a much more accessible Arbitrage trading strategy but does not offer the guaranteed returns offered in the previous example. Pairs trading is the same type of trade where one single is matched against the other but involves trading related or a number of markets as opposed to two instruments related to the same market.

This type of arbitrage trading may not offer guaranteed returns but it can lessen risk to the traders portfolio. This can be done if the pairs are properly matched as one single will perform better at times when the other is doing less well, thereby producing an overall balanced portfolio.

Understand how to calculate Fair Significance

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