Discount Arbitrage

Definition

The term discount arbitrage refers to the practice of simultaneously buying a discount option and taking the opposite position in the underlying security. Discount arbitrage is considered a riskless strategy, since the trader is engaging in a covered option.

Explanation

While stock exchanges are considered efficient markets, there are instances when the mispricing of one or more securities provides the opportunity for profits through techniques such as discount arbitrage. There are two variations of this trading strategy, both of which are classified as riskless investments:

  • Basic Put Arbitrage: involves purchasing the right to put a security at a discount, while at the same time buying the underlying security.
  • Basic Call Arbitrage: involves purchasing the right to call in a security at a discount, while at the same time selling the underlying security.

Related Terms

statistical arbitrage, selling short against the box, arbitrage bonds, stale price arbitrage, international arbitrage