What is: Arbitrage – Understanding Arbitrage Trading With NSE and BSE

Arbitrage is the practice of taking advantage of a price difference between two or more markets or exchanges. In Indian markets, the cash segment 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 can be an arbitrage opportunity.

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.

So if

1. The same asset does not trade at the same price on all the exchanges
2. 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) and 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 execute the transactions manually, but it should be an automated process because the situation may not hold for a long time.
• Always check with your broker if they allow interoperability of exchanges. If they don’t, you can’t trade the arbitrage. (We will see what is interoperability of exchanges 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. Check for Interoperability of Exchanges With Your broker

When I first wrote this article in 2012 about arbitrage opportunities with both the exchanges, we were not allowed to buy and sell the same stock in different exchanges on the same day. If you buy stock XYZ today in NSE, you cannot 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.

However, so the arbitrage opportunity existed only for those who had the stocks in their DP. So, if you have stock XYZ in your DP, you can sell the same in BSE and buy them in NSE to bag a profit. However, you were not doing intraday trading. So you may be paying the brokerage of delivery to your broker though you are trading on the same day – time-wise.

In 2018, SEBI proposed the idea of Interoperability of exchanges. Interoperability now ensures that one can settle trades made on both NSE and BSE through a single clearing corporation. It means the broker can clear the trades of BSE on NSE or vice versa.

However, still, in 2021, not all brokers support interoperability. I am sure eventually they will, but it is still not the norm. I know and have enquired that both My broker Upstox and Zerodha do support it.

2. Last Traded Price of NSE/BSE 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 the 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 difference 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.

1. The offer price is the price that others are offering their shares. So you can buy at the offer price.
2. The bid price is the price that others are willing to buy shares. So you can sell at the bid price.
3. The last traded price is when the offer price and bid price match, 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 exchange.

3. Arbitrage Trades shouldn’t be Manual

As a retail investor, we may be able to spot some arbitrage opportunities.

Still, suppose you try to key in those trades manually. In that case, the opportunity may be gone before you can manually execute the trades. The reason being many big traders 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 what you just purchased. I did the same in Fame India here quite some time back.

Final Thoughts

Arbitrage opportunities exist in many forms in the market but trying to take the buying in NSE and selling is BSE is not the right one to take. 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.