In business economics, investment and sports, arbitrage is the technique of taking advantage of a price difference between several markets: striking a mix of matching bets that capitalize upon the asymmetry, the profit being the differences within market prices.
When employed by academics, an arbitrage is actually a transaction which involves no negative cash flow at any probabilistic or temporal state including a positive cashflow in at least one state; in simple terms, it’s the potential for a risk-free profit at zero cost. In effect free money from bets where zero risk existed.
In banking markets this is known as ‘Arbitrage’. In betting markets it is called Matched Betting.
In principle as well as in academic use, an arbitrage is risk-free; in common use, for example statistical arbitrage, it might mean projected profit, though losses may manifest, and in practice, there are always risks in arbitrage, some minor (along the lines of change of prices decreasing income), some major (which include devaluation of your currency or derivative).
In academic use, an arbitrage involves taking advantage of differences in cost of a single asset or identical cash-flows; in common use, it is usually utilized to refer to differences between very similar assets (relative value or convergence trades), such as merger arbitrage.
Individuals that participate in arbitrage are known as arbitrageurs such as a bank or brokerage firm. The term is primarily given to trading in financial instruments, like bonds, stocks and shares, derivatives, goods and currencies.
Sports arbitrage has additionally recently become possible due to the use of online bookmakers providing widely diverging odds on sporting events making situations where it’s possible to place bets that cannot lose.
And even though this involves bookmakers it is not gambling as there is absolutely no risk to the initial stake which can’t be lost.
Arbitrage just isn’t simply the act of buying a physical product in one market and selling it in another for a better price at some later time. The trades must take place simultaneously to prevent exposure to market risk, or even the risk that prices may change on one market before both transactions are complete.
In functional terms, this is generally only possible with securities and financial products which might be traded electronically, and even then, when each leg of the trade is accomplished the values available in the market may have moved.
Missing one of the legs of the trade (and subsequently having to trade it immediately after at a worse price) is called ‘execution risk’ or more specifically ‘leg risk’.
“True” arbitrage necessitates that there be no market risk included.
