Technical Analysis

Play the arbitrage game

Rajalakshmi Nirmal | Updated on November 22, 2014 Published on July 20, 2014

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As the Indian investor takes to algo trading, high-frequency trading and other technological innovations, you might think that the difference in the price quoted for the same stock on the BSE and the NSE would become almost negligible. But that is far from reality.

On July 18, Hatsun Agro Products’ stock closed at ₹281.40 on the NSE; its closing price on the BSE was ₹277.20. The stock of Motilal Oswal Financial Services ended at ₹246 on NSE, while its price on the BSE was ₹243.10. Running a screener on prices, it was found that a bunch of 30 stocks from the BSE 500 basket was quoting more than 0.4 per cent higher on the NSE on Friday. There were also quite a few cases where the BSE price of the stock was higher. Take, for instance, the stock of Info Edge — the BSE price was ₹693.10, while on the NSE the stock’s closing price was ₹686.70. Tata coffee traded at ₹970.50 on BSE, while its NSE price was ₹965.50.

The way to go

Now, why do such differences exist? “The price difference exists primarily due to the fact that there is no cross clearing between the two exchanges, as is the norm in other countries,” says Raghu Kumar, Co-founder of brokerage firm RKSV. “So, one cannot do arbitrage trades by buying a stock on the BSE and selling the same at a higher price on the NSE and earning a profit from the price difference. The two scrips are basically ‘independent’ from each other. So to do arbitrage one would have to hold shares overnight.”

But given that one cannot hold shorts overnight, is there a way out to use this opportunity? Yes, says Kumar. To profit from such opportunities, “one has to buy the stock on one exchange, sell on the other and then wait for the prices to converge and execute the opposite directions”.

Now, that sounds like a really risky game. Do price differences exist for at least few days or are they short-lived? Nithin Kamath, Founder & CEO, Zerodha, says: “Ideally, these differences don’t last long, because it would give an opportunity for arbitrageurs to make money. But as these differences usually arise in counters where volumes are less, the differences sometimes last for a few days.” However, if one is willing to bite the bullet, there is a lot of money to be made. This is not a small trader’s game though as these work only when traded volumes are higher. Profit margins in the NSE-BSE cash arbitrage have reduced significantly in the last few years, say experts, as algorithm software identify them fast.

RKSV’s Kumar adds: “Back in the days before algorithmic trading, arbitrage trades created huge profits for proprietary trading firms. Clicking away on their mouses, jobbers would look for large price differences and generate sizeable profits.

“As competition stiffened, profit margins thinned out. Nowadays it is very difficult to earn a profit by doing arbitrage between the BSE and NSE.” Still, the conservative bunch of you can benefit from these arbitrage opportunities, says Nitin Kamath.

“Assume stock X is trading at 100 on the NSE and 98 on the BSE, and you hold 1,000 shares of this in your demat already. You can sell it on the NSE at 100 and buy it back at 98 immediately on the BSE, reducing the cost of your stock X,” adds Kamath.

Published on July 20, 2014
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