Arbitrage - A Tool for Making Money.
Alan J. Mendlowitz, RICP, CRES
"Arbitrage is the opportunity to buy low and sell high." – Warren Buffett
Introduction
Arbitrage exists as a method of making money in many aspects of the economy. Some are only available to those with certain technological and financial abilities, but many are things anyone can do to earn a profit and potentially generate wealth. According to Merriam-Webster, arbitrage is the 'purchase of securities in one market and their simultaneous sale in another market' or 'the practice of taking advantage of differing prices for the same commodity in different markets.’ According to Wikipedia[i], in academic use, an arbitrage is risk-free; in common use, it may refer to expected profit, though losses may occur; and in practice, there are always risks in arbitrage. Some risks are minor such as fluctuation of prices decreasing profit margins, and some are major such as devaluation of a currency or derivative.
While the examples of arbitrage in this blog are not things I can help you with in my capacity as your financial advisor, it is worthwhile and necessary to understand the basics of arbitrage as a piece of the puzzle we are putting together in this blog series.
Arbitrage is a core aspect of the global economy, whether you’re a small businessperson selling vintage clothes on Etsy or a major investor trading billions of dollars across currency markets. Ultimately, it comes down to the oldest rule of investment: buy low, sell high.
Investment Arbitrage
“Arbitrage is the essential method by which capitalism realizes its ideal of the equality of opportunity." - Milton Friedman
Interest Rate Arbitrage
Assume Japanese interest rates are very low. This encourages people to buy Yen and borrow from Japanese banks. This low rate of borrowing can then be used to make a profit by depositing the money in countries with high-interest rates.
Negative arbitrage refers to the opportunity lost when the interest rate that a borrower pays on its debt (a bond issuer, for example) is higher than the interest rate at which those funds are invested. The opposite effect could work for an individual who pays one interest rate and earns a higher rate.
Some other forms of investment arbitrage you can learn about include: Commodity/Currency Arbitrage, Statistical Arbitrage, Merger Arbitrage, and Convertible Arbitrage[ii].
Everyday Arbitrage
I'm not a gambler, I'm an arbitrageur." -Michael Jordan
Retail arbitrage
Just like on financial markets, arbitrage can also be performed with usual retail products from your favorite supermarket. On eBay for example, you’ll find hundreds of products bought in China and sold online at a higher price on a different market.
Or let's say you find some old clothes at $50 each in your local thrift shop and you know that at a vintage boutique or on Etsy you can sell them for 500 dollars - that’s 450 profit! But remember: listing fees, transaction costs, shipping etc., can complicate low volume arbitrages like this one.
Some other forms of everyday arbitrage you can learn about include: Sports Betting Arbitrage and Marketing Arbitrage.
Conclusion
As we conclude our blog on Arbitrage, amidst our journey to finding wealth, we have learned that arbitrage exists not just conceptually and among the Wall St. crowd, but practically can be used every day by regular people. While the aforementioned examples are not ones I can help you with there is a way to create your own arbitrage-like opportunities and use them to your benefit! This is part of the Internal Revenue Code Section 7702 and 7702a[iii] which uses insurance company products and benefits to create potential arbitrage using the leverage (see next blog) that it provides. If structured appropriately it can provide the arbitrage with many fixed parameters, in one currency and no need for mergers, securities or complex statistical models! Opportunities without having to gamble, own vintage collections or be involved in sales and marketing! What are you waiting for? Schedule a meeting with me and then read the last blog in the series on Leverage before we meet!
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