As high net worth institutional investors have a direct co location in the exchange servers and have automated trading systems to capitalize on risk fee arbitrage opportunities, Do we retail investors stand a chance in Risk free trading?
Hi Rohan....arbitrage opportunities is not just restricted to HNI and institutions. Retail investors can also spot and trade arbitrage opportunities.
Arbirtrage trading has many variants - some of them require financial and infrastructure muscle to set up the trade which is what HNI's and Institutions have. However there are a bunch of other arbitrage opportunities that require pure intellect. These are opportunities that retail investors can exploit.
Two such arbitrage strategies that are on top on my mind - Pair Trading (also known as relative value trading )and Merger Arbitrage.
In Pair Trading you identify two companies with similar variable - company size, factors influencing earnings, margins, regulations and the works. The premise is if there are two "some what" similar companies then their stock price is likely to move in tandem. In case they dont, then you have an arbitrage opportunity. Ex: ICICI : HDFC, Infy:TCS, Bajaj:Hero Motorcorp etc.
In Merger Arbitrage - You can set up trades by tracking corporate actions in the M&A space. The trades involves studying swap ratios, special dividends, enterprice value, market cap etc. This is far more technical in terms of finance per say. But if you can devote the time and energy, this is totally worth it. Recent examples that I can think of - Pfizer Wyeth deal and the Thomas Cook - Sterling Holidays deal.
Besides these two you have other opportunities as well...Index Arbitrage, Risk Arbitrage, Volatility Arbitrage etc. All these can be set up by retail investors...especially the volatility arbitrage strategy.
So keep your eyes open you may spot the next one :-)
Arbitrage is basically taking an advantage of any mispricing between assets. There are many arbitrage strategies, but some of them depend on who spots the opportunity the fastest.
One such one is Cash Future arbitrage, when the difference between cash and future is more or less than theoretical values, you can setup strategies to profit from such mispricing. But the person who spots it first gets the pie.
In a formula one car race, you cannot hope to win driving a fast rally car, if you know what I mean. ;).
So yes such arbitrage strategies where speed is important, the retail investor will have no chance competing with automated strategies running from co-located servers, but yes there are arbitrage strategies where speed is not important where the retail trader can match up to institutions.
when zerodha will start automated algo for spread trading like cash to cash arbitrage or cash to future etc or any type of spread algo trading.