In Indian markets stocks are traded in two major exchanges – NSE & BSE, which means you can take advantage of buying in one exchange and selling it in the other and bag the difference as profit. Wait …
Arbitrage is the practice of taking advantage of a price difference between two or more markets or exchanges. In Indian markets, stocks trade in the two major exchanges – NSE (National Stock Exchange) and BSE (Bombay Stock Exchange). It means you can take advantage of buying the stock in one exchange and selling it in another and bag the difference as profit.
What is an Arbitrage?
As a quote from Wikipedia
In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices.
- The same asset does not trade at the same price on all the exchanges
- An asset with a known price in the future does not today trade at its future price.
Then we can take advantage of Arbitrage and sell at a higher-priced exchange and buy at the lower-priced exchange to cash-in the profits.
In the Indian market, stocks trade in NSE (National Stock Exchange) as well as BSE (Bombay Stock Exchange). So one has the option of buying stock in one exchange and sell it in the other one.
Wait… there are things to consider, but I would mention some.
- Do not try to execute the transactions manually, but it should be an automated process because the situation may not hold for a long time.
- Always have the stock in the delivery and then execute the sell before you buy it. (We will see why you need it)
- Remember to execute it when you have the cost of your broker covered.
So let’s understand the arbitrage now.
1. Arbitrage is not An Intraday Trade (Cost Wise)
You are not allowed to buy and sell the same stock in different exchanges on the same day. It means if you buy stock XYZ today in NSE, then you are not allowed to sell stock XYZ in BSE the same day. If you do that, you may have a penalty of short selling in the exchange you sold.
It means you can only do arbitrage for stocks that you have in your DP. If you have stock XYZ in your DP, you can sell the same in BSE and buy them in NSE as well to bag a profit but then you are not doing intraday trading, and so you may be paying the brokerage of delivery to your broker though you are trading on the same day – time-wise.
2. Last Traded Price is not the Price for Arbitrage
If you see a price difference of few Rupees in both the exchanges does not always mean there is arbitrage. Take an example of Weizmann Forex.
We see the price in BSE as 69.90 and in NSE as 74.90, which one can conclude as an arbitrage opportunity, but there is no arbitrage opportunity. Let me explain to you why.
The big price number that you see is the last traded price which means those price in both the exchange is the traded price and not the amount at which you will be able to trade.
Your price would be either offer price or bid price. Let me explain the offer price, bid price, and last traded price first in simple terms.
- The offer price is the price that others are offering their shares. So you can buy at the offer price.
- The bid price is the price that others are willing to buy shares. So you can sell at the bid price.
- The last traded price is the price when the offer price and bid price matched, and the trade took place.
So if you see the offer price and bid price in both the exchanges they are
- The offer price in NSE is 74.90 for 48 shares.
- The bid price in BSE is 67.30 for 50 shares.
So if you execute the trade, then your offer price should be 67.30 in BSE and Bid Price in NSE as 74.90, and that would mean you are buying high and selling low making a loss and not a profitable arbitrage.
So arbitrage only exists if you have a higher bid price and lower offer price in either of the exchanges.
3. Arbitrage Trades should never be Manual
As a retail investor, we may be able to spot some arbitrage opportunities. Still, if you try to key in those trades manually, the opportunity may be gone because there are so many big traders who have automated software running for spotting such arbitrages and execute those trades. If you think you can beat those programs spotting arbitrages, you are wrong.
On top of that, you are trading with the broker in between you and the exchange. The large traders have direct access to the exchange. So they don’t have a broker in between, eating their profits. So they can spot arbitrages much earlier than us. By earlier, I don’t mean time early but price early.
It does not mean that retail investors cannot trade in arbitrage, and circuits are the best opportunities for arbitrage where if you have stock in your DP and if it hits the circuit in both the exchange, you can opt to buy in the circuit where the pricing is low. Once the buy order is executed, you can sell your stock from DP in an exchange where pricing is higher than you just purchased. I did the same in Fame India here quite some time back.
Avoid spotting arbitrage in low volume stocks because pair trade execution can be tough in them. If you have any questions about arbitrage, you can ask them in the comments below.