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How To Calculate Arbitrage Profit?

How To Calculate Arbitrage Profit?
by Jerome Foster - January 15, 2022

A disparity between three foreign currencies happens when their exchange rates do not exactly line up, resulting in triangular arbitrage. These chances are uncommon, and traders who take advantage of them generally use sophisticated computer equipment and/or software to automate the process.

For example, a trader using triangle arbitrage would exchange an amount at one rate (EUR/USD), convert it again (EUR/GBP), and then convert it back to the original (USD/GBP), netting a profit assuming minimal transaction costs.

When a currency's exchange rate differs from the cross-exchange rate, a triangular arbitrage opportunity exists. Price disparities are most commonly caused by situations in which one market is overvalued while another is undervalued.

Consider the following scenario: you have $1 million and the following currency rates: EUR/USD = 1.1586, EUR/GBP = 1.4600, and USD/GBP = 1.6939.

There is an arbitrage opportunity with these exchange rates:

  • To purchase euros, sell dollars and buy euros: €863,110 = $1 million x 1.1586
  • To exchange euros into pounds, multiply €863,100 by 1.4600 to get £591,171.
  • Convert pounds to dollars: £1,001,384 = £591,171 x 1.6939
  • Subtract your original investment from your total: $1,001,384 divided by $1,000,000 equals $1,384.
  • You would make a $1,384 arbitrage profit from these deals (assuming no transaction costs or taxes).

You can also use different tools to calculate the arbitrage such as Smarkets arbitrage calculator, here’s how you do it. It's easy to use the Smarkets arbitrage calculator. Simply follow the steps below:

  • Enter the total amount of money you're willing to risk.
  • If you're betting on a betting exchange, enter the odds for result 1 and the commission (if you are between bookmakers set the commission value to 0).
  • Rep for any additional outcomes you'd like to arbitrate (add new outcomes if you require more than 4 outcomes on a market).
  • The arb calculator will then automatically calculate your profit and how much you need to bet on each outcome.

To learn more, click here.

Author

  • Jerome has worked for an international real estate magazine in the past before joining Prudentialcal. He now spearheads our team of writers and ensures the quality of content we produce weekly.

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