- Wealth PMS (50L+)
We continue on the Arbitrage series with a post on inter-exchange arb. We have two popular exchanges in the country (NSE and BSE) and given that you can access both, there is an arbitrage opportunity that emerges between the two.
You could technically buy a stock on the NSE and simultaneously, sell it on the BSE. The difference of prices between the two needs to be enough to handle transaction costs.
Why does this arb even exist? Most institutional purchase are in large numbers and they tend to focus on one exchange – the price in the other, meanwhile, could veer away. The difference is bridged by arbitrageurs or jobbers who buy the lower price and sell the higher.
There is a catch. If you buy on the NSE and sell on the BSE you are likely to have a delivery problem. At the end of the day, the sell transaction requires you to deliver securities on the next day (T+1) but you will receive the buy transaction securities only on T+2. This will result in short delivery on the sell transaction, which causes large fees and penalties and can wipe out any transaction related costs.
See our Video: What is Short Delivery?
So, it’s useful to reduce this risk by squaring off the arbitrage on the same day. Usually prices will go back to convergence and diverge many times during the day so entering at one point and getting out at another will close the arb for the day.
This is probably easier to do using algorithms, who can track many securities and immediately bridge differences between the two sides. It is sometimes done with people on the terminals – and they tend to use special keyboards with two computers, one with BOLT (BSE’s broker terminal) and another with NEAT (NSE’s). Their experience allows them to see when volume flows in one exchange, and they neatly take positions to arb out the difference with the other.
There is, of courses, slippage. What if you are able to get one transaction but not the other? The price could run away before you know it and then you’re staring at a loss that more than offsets your costs.
Our view: Don’t bother unless a) you’re a broker and b) you have access to algorithms that can trade. Slippage can eat up most of your gains. Brokers might be able to hold the arb across days as they can obtain shares temporarily from clients. (Don’t ask how!)
We will have more on this topic. Here’s the topic list:
Do let us know what you think. We aren’t recommending trades, and this is not portfolio advice. Please do understand the risks before you trade.
Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.
Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.