07-27-2001, 01:51 PM
This is not an arbitrage in the pure sense - buying and selling the same security simultaneously for a profit - but it has an arbitragesque quality to it. Let's say you have two stocks in a given sector, and you have a strong idea as to how well they should be doing relative to each other (bear in mind that due to the number of shares outstanding, stock price alone will not give you the whole story. Look at market capitalization, unless you know how they do relative to each other with that factored in.) When the relative difference is out of whack, you can short the relatively expensive one, and long the relatively cheap one. If the market goes up, what generally happens is the 'cheap' one goes up more than the expensive one (which may not go up at all) or if the market goes down, the expensive one goes down more than the cheap one (which may not go down at all). You're just betting that they will get closer together (or further apart, depending) and the specifics are irrelevant. A recent (and current) prime example is AMD and Intel, my favorite pairing. Intel at 30 and AMD at 17 were just two far apart. Since making this play, that gap has been closing, and I expect it to do so until they get pretty close to each other, at which point I'll cash out and switch, and wait for them to get further apart again. Without ever stopping on a dime, they seem to revolve around a point where Intel is maybe $5 more expensive than AMD. Sometimes AMD goes a little higher, sometimes Intel goes much more than $5 over AMD (as is the case now). Generally, they swing back the other way. I noticed this while studying AMD pretty intensively starting about a year and a half ago, and plan to research other sectors for relative disparities between industry leaders. Just a thought.