Types of “arbitrages”/inefficiencies (non quant)
What are some examples of non quant (meaning like non HFT or situations that don’t require a PhD in math to find) inefficiencies and arbitrages in mkts? Things that come to mind include: index rebal arb, merger arb, SPAC arb.
Can anyone comment on technical inefficiencies and situations created by forced selling/buying? Super interested in these types of trades. They seem so pure to me and make so much sense. Thanks!!
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Index rebalancing - created due to the prevalence of passive funds. Take S&P 500; there are 500 companies that are members based partly on certain criteria & partly on the judgement of the board of people set up to add/remove members in S&P. To be added you need to meet certain criteria, so not entirely subjective. When a company drops out of S&P 500, all passive funds need to unload lots of stock, creating forced selling. They need to rebalance to track the performance of S&P 500 and these passive funds are a big chunk of the market (think of Vanguard AuM). Same with when the company is added. Often, the likelihood of being added to a major index is already reflected in the price. The more criteria you meet and the more rumour there is of being added, the more speculators buy the stock hoping to profit from the addition. Once the stock is added, these speculators are selling, while the passive funds are buying, which in perfectly efficient markets would result in no change to share price.
This is a super interesting strat this is often filled with more "quantamental" guys. Millenium made a ton of their 2021 PnL from pods in this strat, and gave it all back this year - this risk profile for these trades is pretty crazy.
Agreed. Must be a very crowded trade though, right? Could you give an example as to how MLP / other pod shops / event driven guys play this? Can’t imagine they just go long the names getting added and short ones getting cut — are they using options / other stuff? An example would be super helpful, thanks!
Also, what other types of trades / situations are similar to rebal arb?
There is a big difference between arbitrage opportunities and what I will call semi-predictable non-fundamentals flows. I won't get into the push / pull of how participants sniff these opportunities out and front-run / eliminate opportunities in many of these more well-known situations, but here's some examples for people to wrap heads around:
-Month End / Quarter End Real Money Rebalancing (Duration Extension, Cross-Asset Class Rebalancing, FX Hedging)
-Fixed Income Auctions (true for all, especially for Corporates)
Made some good money back in the good ol days of 2020 SPAC arb but it's pretty much dead now.
Spin-offs. Joel Greenblatt's "You can be a stock market genius" describes spin-off dynamics very well, along with other types of spec sits.
I second this book. Joel really gets into some good stuff, for example, when company's spin off divisions, the CEO of the spin off usually has a lot of price based options for hte first year, so the CEO will typically make stock boosting maneuvers.
Removed for anonymity. Removed for anonymity.
Very few things labeled arbitrage are actually arbitrage.
Quick trivia: How many stocks are in the s&p 500?
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504. Agree worded well but most people think it’s 500.
Many examples given are “arbitrages” of expected value - majority of investment strategies surely fall under this broad umbrella in some shape or form. Classic buy low, sell high at the same time pure arbitrage is just the simplest EV calculation.
What are some of the equity focused stratgeies focused on this? Other than rebal arb?
Every FICC product in 2022. Margins/liquidity, stupid volatility have been very prevalent. Hence why Bridgewater is doing well.
- convertible bond arbitrage
- ECM trading (predicting liquidity better than others)
- rebalance strategies
- SPAC arb
- corporate action arb
- option arbitrage (mostly HFTs)
I don’t know that ECM is about predicting liquidity as much as (1) making probabilistic mean reversion bets and (2) PROVIDING liquidity.
True but also depends on what the edge in your strat is - there’s different ways to do it
I had a professor who did arbitrage sports betting when he was in college when online sports betting first started popping up. I don’t really remember the exact specifics, but he would bet on one game on one website, and then bet on another on a different website. He turned basically beer money into a few thousand until the FBI (?) shut the website down and ended up holding his money for about a year until he got it back.
Another arbitrage opportunity is wholesaling in real estate. Finding a distressed seller, structuring the contract in such a way that you have zero obligation to close and it gives you enough time to find a buyer. There were tons of people out of my investor meet up that did this to different scales. Some closed a few deals a year and others sent out thousands of letters and texts constantly.
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