Forex Volatility and Profitable Arbitrage

Forex markets have been very volatile in 2015. Events such as the Swiss National Bank decision to remove the cap on the franc and an unexpected devaluation of the Yuan have caused huge losses for some traders and spectacular profits for others. Our interest today is in profit from Forex volatility and short term market inefficiency. The term for this practice is arbitrage and Investopedia explains how Forex volatility can result in profitable arbitrage.

Forex arbitrage is a risk-free trading strategy that allows retail forex traders to make a profit with no open currency exposure. The strategy involves acting fast on opportunities presented by pricing inefficiencies, while they exist. This type of arbitrage trading involves the buying and selling of different currency pairs to exploit any inefficiency of pricing.

Currency pairs are priced one against the other such as EUR/GBP, EUR/USD, GBP,USD. In the Investopedia example a trader buys Euros with US dollars and then sells the Euros for British Pounds. Finally he or she buys USD with GBP. Because of a momentary inefficiency in pricing this strategy turns a virtually instantaneous profit of $13 on $11,837 of trading capital. The strategy starts, in this case, with dollars and ends in dollars and can be repeated continuously until the pricing inefficiency goes away. This strategy leaves no open exposure as long positions and short positions cancel each other out. This strategy provides a tiny profit with each trade and no risk. In times of heightened volatility Forex arbitrage can be carried out minute by minute all day long! One can purchase Forex arbitrage calculation programs to speed up the process and reduce the risk of miscalculations.

Another Approach to Forex Volatility

Bloomberg Business reports on a profitable approach to Forex volatility. This year when more than 400 hedge funds closed their doors a currency manager gained 21% simply betting on volatility.

Quaesta Capital AG, a hedge fund based in the Zurich area, runs a $420 million foreign-exchange options program that earned 21 percent this year through Nov. 11 by wagering on volatility, according to Thomas Suter, the company’s chief executive officer. It’s the top performer among 15 programs tracked by the Parker Global Currency Manager Index, which lost almost 2 percent in that period.

The strategy, dubbed v-Pro, has profited by speculating that swings in major currencies will grow more pronounced as the Federal Reserve moves to lift interest rates from near zero. It’s the only strategy in the Parker index that focuses on volatility, which has rebounded from a record low set in 2014. Quaesta uses dynamic delta hedging – a wager on volatility that requires constant adjustments to make sure it avoids taking a stance on foreign-exchange movements.

Detractors of this approach describe it as more art than science.

Delta hedging should be “performed at every millisecond, so it’s not technically possible and you always have a residual risk,” said Olivier Korber, a derivatives strategist at SocGen in Paris. “The hedging performance can be a loss, flat or even a gain. It is more art than science.”

But the point is that whether one uses arbitrage or the so-called v-Pro strategy there is profit to be made simply because the market is volatile.

Where to Look for Forex Volatility and Profitable Arbitrage

Obviously, if you want to profit from volatility you need to be trading the most volatile pairs on a day by day and minute by minute basis. FX Street writes about USD: Currency Index and Volatility. To make money with this approach you need be at your trade station throughout the day deciding where to trade and doing so on a second by second basis. The payoff is that Forex volatility can lead to profitable arbitrage.