CHAPTER 9Trading Tactics

When an arbitrageur takes a position in a particular arbitrage transaction, he or she must decide how to execute that decision and how to implement it with an overall portfolio strategy. In this chapter, we will explore the execution of trades and the tactics that arbitrageurs use to set up and unwind positions.

DETERMINING POSITION SIZE

An arbitrageur must initially determine a maximum position size in any given transaction. The maximum size will relate to either the overall equity capital that the arbitrageur is utilizing, or the risk in the individual position as it relates to this overall equity capital. Chapter 10 explores in depth the method by which arbitrageurs should limit their position size.

At this point, however, if we assume that the arbitrageur has determined the maximum position size—for example, either 10% of the overall buying power in the portfolio, or a maximum loss of 2.5–5% of the portfolio's capital—the arbitrageur knows the dollar amount of that maximum position. This amount is considered by the arbitrageur to be a maximum or full position size. Rarely is a full position put on at one time. An arbitrageur will usually determine, when he or she is initially making hedges, whether to start by taking out ¼ of a position, ½ of a position, ¾ of a position, or a full position.

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