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Courses Glossary Register Login Home     Financial Terms and Glossary     Index arbitrage Index Arbitrage

Index arbitrage is a trading strategy that takes advantage of price discrepancies between an index’s futures contracts and the underlying assets in the index. Traders engage in index arbitrage by simultaneously buying the undervalued asset and selling the overvalued asset to profit from the price difference. This strategy is commonly used by institutional investors and hedge funds, especially in markets with high liquidity. Index arbitrage helps ensure market efficiency by bringing prices in different markets closer to equilibrium.

Example:

A trader notices that the S&P 500 futures contract is trading below the value of the actual index. The trader buys the futures contract and sells the underlying stocks, profiting from the price discrepancy.

Key points

• A trading strategy that exploits price differences between an index’s futures contracts and the underlying assets.

• Used to bring prices closer to equilibrium in different markets.

• Commonly employed by institutional investors and hedge funds.

Quick Answers to Curious Questions What is the goal of index arbitrage?

The goal is to profit from price discrepancies between an index’s futures and its underlying assets while ensuring market efficiency.

Who typically uses index arbitrage?

Institutional investors, hedge funds, and traders with access to sophisticated technology and large amounts of capital often use index arbitrage.

How does index arbitrage contribute to market efficiency?

By exploiting price discrepancies, index arbitrage brings prices in different markets closer to equilibrium, promoting market efficiency.

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