Arbitrageurs in search of Golden Opportunities

After almost a year of often intense debate about the potential duration of the global economic downturn and despite recent gains across the commodities and now equities markets, informed pundits continue to express reservations about the durability of a general global economic recovery. With such negative sentiment seeming only to further propagate market fluctuations, savvy arbitrage traders have their foot on the accelerator for cashing in on fickle market pricings.

As we know, investing is all about degrees of risk (and return), and critically, to know precisely where risk lies and use it for advantage. In theory, an arbitrage is a risk-free transaction. While some economists might argue inherent risk exists in tim-ing given all markets eventually find true equilibrium, arbitrage is more about the arbitrageur’s ability to create the opportunity, relying on his technology for timing and speed to ensure the opportunity is acted on, with profit realized.

Arbitrage – a case example

Boiled down, many arbitrage opportunities reflect very minor pric-ing discrepancies that either exist, only ever temporarily, between markets or are created by the arbitrageur. Per transaction profits tend to be small and can sometimes be consumed by transaction costs. To counteract this we are currently seeing some exchanges offering incentives such as sav-ings on fees in the hope of at-tracting additional traders, par-ticularly arbitrageurs.

In its simplest form, consider that Gold futures contracts are trading on NYMEX at a bid of $935.20 an ounce and on NYSE Liffe at a bid of $934.90 an ounce. The arbitrageur created the arbitrage opportunity by bidding $935.00 on NYSE Liffe with a resulting hit on the bid, followed by a sell order at the bid of $935.20 on NYMEX. Sounds simple, but key to the success of this strategy is multi-market and fast direct access to these markets.

And as new markets win favor with these investors, the chal-lenge of course is to come up with faster market gateways to new sources of liquidity.

“Increasingly arbitrage traders and futures market makers are using Orc technology to trade gold derivatives, very much relying on Orc’s proven multi-market, low-latency trading solutions,” says Markus Kämpe, Senior Product Manager at Orc Software. “We have for some time known we have a strong solution for ar-bitrage trading and of late have seen increased interest for this from the Gold derivatives market.”

Gold enjoys market run to challenge all-time high of $1,032.70

Attracting many arbitrage opportunists, there are numerous exchanges listing Gold derivatives globally with most express-ing unit values in USD. During the last couple of years additional Gold markets have also appeared. The list of exchanges now includes NYMEX, MCX, TOCOM, NYSE Liffe US, TAIFEX, SHFE, DGCX, TFEX, FORTS, HKex, Eurex etc. Most inter-exchange Gold futures trading strategies involve NYMEX, by far the most liquid Gold futures market.

Next to NYMEX, Tokyo’s TOCOM is also considered a primary futures exchange for gold trading. Both these exchanges are

general purpose commodities exchanges that trade sub-stantial numbers of futures contracts. During the first two weeks of June 2009, NYMEX alone has averaged daily vol-umes of around 100,000+ Gold futures contracts.

In the Middle East, total volume on the Dubai Gold and

Commodities Exchange (DGCX) for May 2009 reached a record 158,074 contracts – their highest monthly volume achieved in 2009 and a year-on-year volume increase of 77%. As is the case with other exchanges, higher volumes were in major part driven by renewed interest in Gold as a safe haven.

Orc Software examines the criteria for profitable arbitrage trading on Gold derivatives markets. Chief Marketing Officer Annie Walsh taps market insight from Senior Product Manager Markus Kämpe to define the underpinning technology required to turn profits.

Increasingly arbitrage traders and futures market makers are using Orc technology to trade gold derivatives, very much relying on Orc’s proven multi- market, low-latency trading solutions”“

“DGCX is an example of a very interesting market for Orc,” says Markus Kämpe. “Based on discussions with the market par-ticipants at the exchange, it is clear there is a need for good market making and arbitrage trading solutions. As part of Orc’s development of a strong offering for the Middle East we are now completing connectivity to DGCX and we expect a significant uptake of our trading solutions for Gold derivatives in the region. In addition to DGCX, Orc recently finalized connectivity to TOCOM and we feel we now have not only strong trading solutions for Gold derivatives, but also a strong connectivity offering for Gold derivatives.”

Basab Banerjee, Head of I.T. at DGCX comments on Orc as a new ISV at the exchange: ”We are confident that our members will benefit from market making and arbitrage trading solutions from Orc in the future. Due to its strategic location between the time zones of the East and West, DGCX offers numerous arbitrage trading opportunities for cus-tomers across the globe. For example, with its USD de-nominated one kilo bar Gold futures contract which has the additional advantage of being transacted and cleared within the favorable tax envi-ronment of the UAE.”

The liberalization of China’s gold trading market influ-enced the Hong Kong Futures Exchange (HKFE) to resume gold futures trading in late 2008. Trading had been suspended during the 1990s due to low demand and few participants. After this lib-eralization it was not long before the Shanghai Futures Exchange (SHFE) launched gold futures trading (January 2009), offering a contract size of 1kg. Given the world’s major gold futures ex-changes trade and settle in US dollars and that the Shanghai fu-tures market trades in Yuan, the Hong Kong futures market can also help investors reduce risk and provide arbitrage profit op-portunities from currency fluctuations.

There is considerable interest among foreign investors for commodity derivatives trading in India. MCX, its major commod-ity derivatives exchange with very good electronic liquidity in futures, and though currently closed to foreign investors, there are industry rumors suggesting this may change in the not too distant future.

Smaller worldwide exchanges attempting to attract more inves-tors and increase market share for Gold trading are adopting savvy marketing practices. One such example is Eurex which introduced Gold futures in January 2009 and has until now (June 2009) waived fees for trading these products. Tactics like these are likely to attract arbitrage traders as well as proprietary trad-ing and brokerage firms.

Kämpe says: “We see significant opportunities for our clients to participate in arbitrage trading and market making activities at Gold derivatives exchanges globally. The trading strategies used in arbitrage trading and market making are very similar, which means trading and brokerage firms through deploying a market making strategy, can make profits on arbitrage trading and receive fee waivers based on their market making agreements with the exchanges.”

Futures spreading and arbitrage trading require sophisticated solutions that are fast and smart. One without the other can leave firms exposed and vulnerable.

“The recently released Orc Spreader was brought to market after close development collaboration with high frequency futures spread traders aiming to use it for capturing arbitrage opportu-nities,” continues Kämpe. “As a server-based, arbitrage trad-

ing solution, the Spreader leverages the Orc Trading platform and works seam-lessly with our market connections. The Spreader further strengthens Orc’s already proven arbitrage trading offering for clients wanting a product that already contains the arbitrage trading logic they need. Other clients looking

to fully customize arbitrage trading strategies can select Orc’s algorithmic trading solution.”

The Orc Trading engine is capable of handling a large number of spreads with sub millisecond latency. The ultra-low latency market gateways allow orders to be rapidly delivered to the exchange. Used with Orc Trader, the Spreader can deliver with the response times required for reducing missed hedges or hung trades, thereby providing the reliability needed to trade in volatile and turbulent markets.

“This is a futures spread trading solution that has proved faster than other products we have tried. We are now able to capture op-portunities that once were lost and mitigate our risk in fast moving markets.”

Chris Snyder, Head of Trading at Chicago-based Fox Trading

Arbitrageurs looking to rapidly deploy a complete trading solu-tion that can be customized on-the-fly in response to changed market conditions should be speaking with Orc today about its latest arbitrage offering.

We see significant opportunities for our clients to participate in arbitrage trading and market making activities at Gold derivatives exchanges globally”“

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