Arbitrage trading is the practice of buying and selling the differentials in market valuation between an asset listed in different markets, or between two closely correlated assets. Examples of binary arbitrage trading exist in the following instances:
- Stock (or indices) and its futures (or index futures) counterpart.
- The same stock, listed in different stock exchanges. An example is a stock of a European company listed on a US exchange as an American Depository Receipt (ADR).
- A commodity like gold can be traded in the commodities- (such as the Chicago Mercantile Exchange) and the futures market.
Arbitrage Trading Tip
For arbitrage trading you have to use binary options brokers which are NOT using the same underlying plattform. We recommend Traderush (SpotOption platform) and EZTrader (this broker has its own platform).
For instance, a stock index is traded as a futures- and as an individual index asset. If you look at the platforms of brokers who use the SpotOption white label platform, you will see that almost all the stock indices listed on the platform are traded as index assets and as futures assets. So while an index such as the Dow Jones index is only traded at certain hours of the day (usually from 1.30GMT to 7.30GMT), the Dow Jones future is traded for a longer period of time. Traders can then trade arbitrage contracts on these assets.
The principle behind arbitrage trading is that there are periods of time in which the price of an asset listed in one market may lag behind the price value of the same asset listed in another market. After some time, the markets will cover the lag in valuation and the lagging asset will eventually catch up with its mate in terms of market value. By being able to pick out periods of price lags, the trader can then profit from the move that will occur when the lagging asset catches up with the leading asset. We gave an example of the Dow Jones stock index and the Dow Jones future. An event such as the Non-Farm Payrolls report, which is released at 1.15GMT every first Friday of the new month, will impact the Dow Jones futures asset instantly. But because the index itself does not open until 1.30GMT, we will see a lag, which will be covered as soon as the index opens for business.
It does not always have to be the same asset listed in different classes. It may be securities which have a close correlation such as commodities and the commodity currencies. For instance, there is an inverse relationship between crude oil prices and the value of the US Dollar. Therefore, you would expect the value of the EURUSD to rise when there is an increase in oil prices, as a result of the inverse affectation of the US Dollar in that currency pairing. Similarly, a rise in crude prices will see a fall in the value of the USDCAD, to reflect the inverse relationship between crude oil and the USD, and the direct relationship between crude oil and the Canadian Dollar (the currency of the country with the second largest oil reserves). There is usually a lag factor at play. So if a trader sees big moves in crude, he can decide to perform a binary options arbitrage trade on the commodity currency pairing, depending on the direction of the move. This is also called a Commodity Forex arbitrage.
In order to perform a binary options arbitrage trade, traders should always note that such opportunities exist all the time; it is a matter of identifying what opportunities exist and how to make the best out of it. In addition, the lag in valuation is a temporary phenomenon that may last just minutes, as such speed of execution is of the essence in deciding what moves to make.