pair trading vs arbing


Active member
As I understand it, pair trading is when you take 2 trades in opposite directions in similar instruments anticipating that the difference in the instruments will either converge or diverge in your favour.


If the difference between the Dax and the FTSE has increased and the Dax has risen by more, in percentage terms then sell the Dax and buy the FTSE in equal amounts, anticipating that the gap will close.

but isnt that the same as arbing?

Pairs is the terminology used more often to describe trading equity pairs ie BP vs Shell, or Vodaphone vs Orange.

FTSEvsDAX type trading is more often called spread trading.

Arbitrage is just a general term used to describe exploiting small price differentials between related instruments with "low" risk.

That last bit is often a fallacy though - the Gilt/bund spread blew out recently and behaved more like an outright that a spread - ie trended massively.

Some people scalp these kinds of spreads for 2-3 ticks, or a bit more. CAC Eurostox is quite popular, and in bonds there are loads
I think arbing is generally thought of as looking for a gap in quotes in the same instrument. You can do this with spread betting using two spread bet firms but there is a risk that the gap will close between placing the first bet and placing the second bet.
oh right, so trading the same instrument but using different trading platforms.

cant see how it would work with spread bet firms though, with the spreads so wide and everything electronic these days, the trading opportunity can only last a few seconds, wouldnt have thought it would be possible to get the trades on quick enough.

Do any of the spread bet firms allow computer automated trading?
i think with 'arbitrage' you are describing a trade where the only risk comes from 'time'. ie. you get one trade but the market moves before you get the other.

arbitrage is not necessarily the exact same instrument. you could arb between the S&P e-mini and the S&P full future.

it is also possible (though very rare) to arb with the same SB company. I have seen a spreadbet companies cash price go up whilst their futures price 'gets stuck'. obviously they are having computer problems but you can take advantage of that with an arb between the two.
Merger arbitrage is or maybe was a favourite with hedge funds, where it is seen as a "done deal" and exploiting differnces in relative stock prices - ie buying target as a cheap way of buying the bidders stock etc

Problem is if deal comes undone...

BOS buying Natwest, that blew up in their faces, seem to remember reading that someone took a £100 million bath.
option arbitrage

I have been reading recently about how options market makers operate through arbitrage. It's like this:

You buy stock and you sell synthetic stock -

synthetic stock is long call option, short put option. For simplicity let's say that the stike and expiry are the same. You look for a discrepancy between the stock price and the synthetic stock price. You buy one and sell the other.

This is known as a conversion and the equation comes down to this:

call price - put price (-call parity or + put parity) > interest expense - dividend recieved.

For profit the left side must be higher than the right side. There is also a reversal but that's another story. I think arbitrage like this is the only 'guaranteed' way to make money in the markets - but it's hard and quite boring. It finally explains to me why interest rates have such a high baring on all of these markets.

You had a go at this mate ? If so, what were the results ol' son ?


The General.