What arbitrage is and where the profit comes from

7 min read · We don't guess the direction — we make money on the price difference of the same thing.

Level:

Short version for experts: tables, lists and screenshots only.

Words in this lesson (9)

Long — Buying in the hope that the price will rise. Buy lower, sell higher.

Short — Selling in the hope that the price will fall: you sell something borrowed, then buy it back cheaper. You make money when the price drops.

Spread — The difference between two prices. In the order book — between the best bid and the best ask. In arbitrage — between the price of the same asset on two venues.

Arbitrage — Making money on the price difference of the same thing in two places: buy where it's cheaper, sell where it's more expensive.

Opportunity (arbitrage pair) — A pair of trades in arbitrage: where we buy and where we sell.

Funding — A regular payment between those who are long and those who are short on a perpetual futures contract. Who pays depends on whether the futures price is above or below spot.

Spot — Ordinary buying and selling of the coin or stock itself: you buy it — it's yours.

Futures — A contract on the price of an asset. You don't receive the coin itself — you gain or lose on the price change. Lets you short and use leverage.

Position — An open trade: what you have bought or sold and haven't closed yet.

The main idea

A typical trader tries to guess whether the price will rise or fall. An arbitrageur doesn't do that. Their job is to find a place where the same thing costs different amounts, buy the cheap one, sell the expensive one and wait for the prices to converge.

An everyday example. At one market tomatoes cost 100, at the next one — 110. Buy here, sell there, make 10 minus the trip. You don't care whether tomatoes get pricier or cheaper tomorrow: you make money on the difference, not the direction.

Words you can't do without

Spread — the price difference between two places, in percent.
Opportunity (arbitrage pair) — a "where we buy — where we sell" pair.
Legs — the two trades that make up an opportunity: the buy leg (long) and the sell leg (short).
Widening — the spread got wider. Convergence — the spread narrowed.

Why prices diverge at all

Exchanges are different venues with different participants. On one there are many buyers right now, on another — sellers. Arbitrageurs are exactly the ones who even the price out, and the market pays them for this work. The less known the coin and the stronger the burst of interest, the longer the divergence lasts.

Why the position is "neutral"

We buy and sell the same number of coins. If the coin rises 10%, the buy leg gains 10% and the sell leg loses the same. In total — zero. All that's left is the change in the spread.

Event	Buy leg	Sell leg	Result
Coin +10%, spread unchanged	+10%	−10%	0
Coin −10%, spread unchanged	−10%	+10%	0
Spread converged by 1%			+1% minus costs

Three kinds of opportunities in MAMAY

Label	What it is	What we earn on
S↔F	spot on one exchange, perpetual futures on another	spread convergence and funding
F↔F	perpetual futures on two exchanges	spread convergence, the funding difference
FUND	spot and futures on the same exchange	funding — regular payments

Funding gets a lesson of its own.

Arbitrage is not "risk-free money". The risks are different from regular trading, but they exist: the spread can widen further, a coin's withdrawals can be suspended, one leg can be liquidated. We'll go through all of them in turn.

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