Arbitrage / scalping is one of the oldest trading strategies. With binary options, you can take a spin on the strategy that has brought many traders decades.

 

 

What is arbitrage?

Arbitrage, or ‘scalping’, is a classic trading strategy that has been around for hundreds of years. Simply put, it is the technique of buying an asset cheaply in location A and immediately selling it at a higher price in location B.

Assume that a share is selling for £100 in London, while at the same time a dealer in New York is offering £101 to buy it. If you bought the stock for £100 and sold it for £101, you would make a profit of £1. It’s not much, but because both trades happen at the same time, there is no risk. The profit is guaranteed, which is why even a small profit is worth the investment.

Additionally, most arbitrage traders trade larger quantities to make up the small profit from each individual quantity. Since there is little to no risk, they can invest a higher percentage of their account balance in each trade and earn the same profit as a trader with a riskier strategy and a smaller investment.

Accounts

To spot these opportunities, traders need access to asset prices. In the binary markets, this can only be achieved by having trading accounts with several brokers.

Dictionary definition of “arbitrage”.

The simultaneous buying and selling of assets or derivatives in order to profit from different prices for the same asset.

The Arbitration Process

  1. Monitor a market or asset. Check values with a variety of brokers or market makers.
  2. Where values differ and cover the costs of trading, an arbitrage opportunity has arisen.
  3. Open positions at both ‘Buy’ and ‘Sell’ prices. Set trade size to ensure profit.

Types of arbitrage

There are a variety of arbitrage structures, or ways in which they can be used. Different markets need slightly different things to guarantee profit. Here we explain some of these differences;

  • Traditional – the usual, or most common, form of arbitrage is where an asset can be bought and sold at two prices. The trader can buy at the low price, sell at the higher price and – after trading costs – still make a risk-free profit.
  • Betting – Betting ‘arbing’ follows the same process. However, rather than having an asset value, a sports bettor can choose the same option. If the assumption is that the prices are different enough, the trader can lay at a lower price than the option is at the price. With sufficient size of the stake, a profit can be ensured regardless of the outcome of the sports event.
  • Forex – Traditional arbitrage is extremely unlikely on major forex pairs. However, it is possible to achieve foreign exchange in the longer term by using interest rates. However, constantly moving exchange rates does not always mean zero risk, and it is not something that retail investors can easily achieve at low cost.
  • Binary – In binary options, traders need volatile markets. This can lead to different payouts with different brokers. The ability to trade both sides of a digital option enables arbitrage – at least one payout must be higher than 100%. In the absence of volatility, the one-sided market sentiment is the only other driver that can cause unusual payout numbers.

Arbitrage strategy

With binary options, an arbitrage strategy is very different from a classic arbitrage strategy. A classic arbitrage strategy is based on the feature that there are several large markets where you can buy and sell things, and that you can sell in one market what you buy in another.

Binary options do not have such a central market, so you need to slightly change the arbitrage strategy. Although the arbitrage opportunities are limited compared to assets such as stocks, there are some opportunities.

Here’s what you can do:

  1. Compare different brokers: Each broker creates its own payouts. If you compare several brokers, you may find that you can invest in the rising prices of an asset with one broker and in falling prices with another, and receive a guaranteed payout of more than 100 percent – a guaranteed profit.
  2. Compare similar stocks: Many news have more than one stock. If the central bank of a country decides what to do with the base rate, banks usually experience strong consequences. By predicting rising prices for one bank and falling prices for another, you can
  3. Compare linked currencies: currencies are always traded in pairs. If you take three currencies, you get three pairs. Often you will find arbitrage opportunities where you can combine these pairs to effectively guarantee a combined payout of over 100 percent.
  4. Compare linked assets: The relationship between the US dollar and oil / gold is often inverse. If the dollar goes up, oil goes down. This relationship also provides arbitrage opportunities. The best opportunity for these types of trades is during times of high volatility, for example immediately after the release of important news.

Is arbitrage illegal?

No. Arbitrage is not illegal. There are rare opportunities, but where the same asset can be brought and sold for a guaranteed profit, it is perfectly legal.

Risks associated with arbitrage

A key point that makes arbitrage opportunities so rare is the cost of trading. Generally, traders can buy and sell the same asset whenever they want – but this will result in a small loss. There is usually a spread, or trading margin, to make up. If an asset is brought and sold, the trading costs will mean a small loss. This is true even if the asset was brought and sold at the same price.

Any arbitrage formula or calculation thereof must include these trading costs. Failure to do so will guarantee a loss rather than a profit.

Another risk is that prices change. Any price difference is likely to be corrected quickly. If these corrections occur before both sides of the trade are placed, the chance for profit closing disappears. Where trades are placed across different brokers or trading platforms, this risk is high.

Commercial Software

Brokers with comparable asset prices: