Arbitrage is a term used to describe the purchase of a product which is then immediately sold to make a profit. Arbitrage is popular in the stock market or as a means to make profit from goods being sold at differing prices in varying markets. A person who uses arbitrage is called an arbitrageur.
A very simple example of arbitrage would be:
While this is a simple version of arbitrage, it should be noted that in small volume deals such as this, it is unlikely that the consumer would be able to make a long term profit for the following reasons:
- Supposing a stock on the NYSE is not in line with the stock's corresponding futures contract on OCX. The more inexpensive stock or contract can be purchased and then sold at a higher price on the other market.
- Hedge funds can also use arbitrage to make a profit. Instead of purchasing and selling the same asset, a hedge fund might purchase and sell different derivatives, assets and securities that have similar characteristics. This practice lets the hedge fund "hedge" any big price differences between the two assets.
In summary, arbitrage basically means the exchanging of one thing for another to take advantage of price differences in two markets, hence earning a profit.