If you follow the financial markets closely, you must have come across the term ‘arbitrage’. Most people assume that arbitrage must be some complicated financial instrument beyond the pale of the average investor. However, this is not true. Read on to find out more about arbitrage trading, types of arbitrage trading, and the benefits of arbitrage funds.
- Arbitrage Meaning
Put simply, arbitrage is any transaction that involves the simultaneous buying and selling of the same asset in different markets in order to exploit the price difference of the asset across markets. This price difference is called the spread and constitutes the profit of the trader. Arbitrageurs take advantage of the fact that markets are not always completely efficient, and price discrepancies across markets for the same asset open-up arbitrage opportunities.
- Types of Arbitrage Trading
Arbitrage trading can be done across any asset class as long as there exists a potential to exploit price differentials across markets. Arbitrage trading comes with lower risks as the buying and selling price are already known to the trader. However, the profit is also small, and spotting arbitrage trading opportunities requires advanced software and trading platforms. This is why arbitrage trading is mostly engaged in by hedge funds and institutional investors. Some common types of arbitrage trading are currency arbitrage, cryptocurrency arbitrage, gold arbitrage, tax arbitrage, credit card arbitrage, etc. to name a few.
- Benefits of Arbitrage Funds
Since profiting from arbitrage trading requires access to advanced software and algorithms, the easiest way for retail investors to benefit from arbitrage trading is to invest in arbitrage funds. Arbitrage funds are mutual funds that deploy the strategy of arbitrage trading to generate returns. The benefits of arbitrage funds are:
1. Low-risk – As the buying and selling price of the underlying asset is known in advance to the fund manager, there is very little risk in arbitrage funds.
2. Tax Benefits – Even though arbitrage funds give near assured returns, they are treated as equity funds as the majority of their exposure is to the equity markets. Due to this, they attract a Dividend Distribution Tax (DDT) of only 10%. Long Term Capital Gains Tax (LTCG) on arbitrage funds is exempt up to Rs. 1 Lakh per annum and only 10% above that while Short Term Capital Gains Tax (STCG) is levied at 15%.
3. Ease of Investing – Arbitrage funds are like mutual funds and are accessible to retail investors through their online demat account or their broker.
- How to Invest in Arbitrage Funds
You can invest in arbitrage funds using your online broking account. Several reputed brokers such as Motilal Oswal allow the facility of investing in arbitrage funds through their online broking account To open an online broking account all you need is to fill a simple online application form, provide your KYC details, and link your bank account to your online broking account.
Arbitrage trading takes advantage of market inefficiencies and capitalizes on the price differences across markets for the same asset. Arbitrage funds are instruments that generate returns from arbitrage trading using advanced software and algorithms. They offer investors the benefit of low-risk and greater tax benefits. One can invest in arbitrage funds using one's
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