Option Arbitration in Forex Market:
What is arbitration? Arbitrage is the simultaneous buying and selling of identical financial instruments taking advantage of price discrepancies between different brokers, exchanges, clearing firms, etc. and so looking for a profit. On paper, arbitrage is a trading strategy without risk. In the real world, however, risks abound.
Why choose arbitration? Well, if the risks can be managed, arbitration can be very profitable if you can find the opportunities and take advantage of it before they disappear. After all, the arbitrage opportunity is present because one side is slow to react to market news, momentum, etc. When the opportunity is corrected is gone.
Why Forex arbitrage options? Well, because the opportunity exists if you are looking for. Forex market is a cash inter-bank / inter-dealer market. In simple terms, this means that currencies traded on Forex are traded directly between banks, exchange houses and Forex investors who want to diversify, speculate or make hedge their currency risk. The forex market is not a “market” in the traditional sense, due to the fact that there is no centralized location for forex trading and therefore, transactions forex are considered over-the-counter (OTC). Forex trading between parties occurs through computer terminals, exchanges and telephones at thousands of locations worldwide. Therefore, the forex market is not as efficient as the New York Stock Exchange, for example. Price discrepancies exist between trading platforms, clearing firms, banks, etc. only for a short period of time. The options pricing is also affected for the same reasons but because besides the price of the underlying currency are other components involved in the valuation of options, tend to exist for longer periods of time.
One of the most common causes of differences in the valuation of options is the calculation of volatility. Volatility is usually the standard deviation measured over a period of time. That sounds simple enough right? Well, if we compare the extent of volatility providers forex options different, most likely find differences as large as 2%. To find You probably you have also found an arbitrage opportunity.
Now that you have found the arbitrage opportunity, how do trading? Well, that’s a bit trickier and this article can not cover all risks associated with making trades, but will list some aspects that must be taken into account. First, are the options really the same? Are the contract sizes, expiration dates and periods the same? In American or European style?
You also need to consider the risk of execution. If Will there be any slippage? If will there be a time delay in getting full? If the market is moving too fast? Exit strategy, how you will exit the trade and still capture profits? What if the options expire in money? ¿Out-of-the-money? What if you are assigned the position in an option, but not the other?
These are just some of the issues to consider when trying to take advantage of arbitrage options. The key to arbitrage options is no different than any other type of trading – planning and risk management. Plan the trade, manage its risks, and execute the plan and you will have success.
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