There are an awful lot of products and services being given away nowadays. Everyone has an advertising model at play, but you and I both know that won’t last forever. How do you capitalize on the this latest (and it seems, recurring) trend before it whithers? Well you could start an arbitrage fund - the targeted spread being an investment in the free services, and a short of the entrenched, charging corporates.

Interesting idea, but private company valuations are somewhat arbitrary, while listed stocks are easy to get a fix on. Figuring out how much to bet (which is just as if not more important that actually picking the winners and losers) on each side of the arb play is the missing link here.

A Guardian Unlimited report yesterday declared Citigroup embroiled in bond selling scandal. According to the report, a couple of traders on the other side of the pond purportedly exchanged a memo where they conspired amongst themselves to make some money. Can you believe it? Securities traders planning to make money. As far as I can see, the only stupid thing they did was talk about it too much before they actually did it.

Excuse my sarcasm.

Ok, so these two traders hatch this plan to make some arbitrage profits. For those not in the know, arbitrage is the process of simultaneously buying and selling different (but often related) assets, in order to profit from the widening or narrowing of the price differential between said assets. In this case, the folks involved saw discrepancies in prices between German government bonds and cash bonds traded on the EuroMTS, the culprit being the varying liquidity between the two markets. Now the Eurex futures market is supposed to provide some balance here, but it, according to these traders, was not doing its job very well. So they decided to flood the market with paper, wait until the remaining liquidity dried up, then buy those same bonds back on the cheap.

Hey guys, next time you get ready to do this, please let me know, so I can toss a few bucks at you.

Crap-munch! This kind of thing has been going on since markets have been in existence. If EuroMTS, can’t take the heat, maybe they should get out of the kitchen (translation: if your market is short on liquidity, it isn’t going to last). Quit and let someone else have a go.

Now the Citicorp CEO is forced to do a little dance, and act like this was bad, and that heads will roll. Hey, I didn’t hear much pissing and moaning when ExxonMobil reported its largest earnings in history (see Dallas Business Journal article). That’s because the profits are coming out the little guys’ pockets, not some multinational “for-profit” market-making system. And for those that will soon whine about Citigroup having the wherewithall (i.e. pile of cash) to pull this off, well here is an analogy for you:

In a no-limit poker game, is the player with the short stack allowed some kindness from the players with the big giant stacks? NO NO NO! The short stack gets pummeled like a rotten melon, and sent home with tail between legs. Poker table = pure free market; European futures exchanges = need some work.

If you want to learn more about these markets, how they work, and how they are sometimes “stacked” for advantage, here are a few books worth reading:

Liar’s Poker by Michael Lewis (a classic) - get it here;

The Vandal’s Crown by Gregory Millman (limited availability)- get it here;

and for the hardcore study beast with ample time on their hands…

The Complete Arbitrage Deskbook by Stephane Reverre - get it here.

NOTE: the author does not condone breaking securities laws (including but not limited to illegal market manipulation), bankrupting third world governments, or churning the accounts of anyone’s grandmother. Please feel free to provide commentary regarding what these folks actually did that was wrong - I am happy to lay down if I am in err.