Arbitrage is the practice of taking advantage of a price differential between two or more markets. A true arbitrage opportunity is risk free. A person who engages in arbitrage is called an arbitrageur. The term is mainly applied to trading in financial instruments, such as bonds, stocks, derivatives, commodities and currencies.
While we are updating, you can learn about how Warren Buffett profited by arbitrage early in his investment career.
Pay Per Click Arbitrage
Also know as PPC arbitrage or Adsense arbitrage, this for of arbitrage involves purchasing online advertising at a certain cost per click and then directing traffic to pages which contain higher paying ads.
Online ad services like Yahoo! Search Marketing (Sign up and get a $25 credit.) and Google Adwords allow you to purchase online advertisements which cost you an agreed upon cost per click. These are known as PPC (Pay Per Click) ads. Some ad clicks will cost advertisers $0.01 while some can cost well over $10 depending on the keywords that were associated with the ad. Yahoo and Google both have programs which allow web publishers (aka owners of websites) to place ads on their own websites to make money. Some webmasters will make a website associated with a high paying keyword(s) and place PPC ads on it. Then, they will purchase low cost ads on Yahoo and Google for their websites. The end effect is traffic arbitrage. Low cost traffic is redirected towards pages which contain high paying links. Enough money is made from clicks to cover the traffic cost and turn a profit.
This is not arbitrage as defined above. The owner of the website is simply betting that the income from the affiliate marketing organisation is more than the cost of bringing visitors to the site. The website owner must pay the search engine for each visitor to the website but payment from the affiliate only occurs if the visitor actually clicks onto one of the affiliate advertisements. A classic example might be where each visitor to the site costs the site owner 10 cents but an affiliate marketer will pay the website owner 10 dollars if that visitor clicks through to the target website. In this case if more than 1 in 100 visitors click through then the site makes a profit; and conversely if less than 1 in 100 click through then the site makes a loss. The same theory holds true if the affiliate is the same (or another) search engine.
Risk arbitrage is also know as merger arbitrage. It is an event driven strategy. It is most commonly associated with corporate mergers. Some mergers involve a fixed cash payment to shareholders. Other mergers involve the exchange of stock. Hedge funds and institutional investors are heavily involved in profiting from these opportunities.
However, there some opportunities in risk arbitrage that can be profitable for individual investors. Fat Pitch Financials Contributor's Corner tracks many of these opportunities. They include reverse splits, going private transactions, tender offers, and split-offs.