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.