Vigorish.wordpress.com is a private forum detailing arbitrage and hedging opportunities in equities, bonds, derivatives and convertible securities. I am not certain of how to proceed with the blog; however due both to technical matters and my desire to keep opportunities “close to the vest,” I do want to limit the audience to 35 individuals. Candidates will be selected based on the quality of their ideas (submitted to me via email).

Wild Card: Well forget about EMH, would you agree a lot more riskless opportunities exist now than say…back in 2006?
How highly efficient can this market really be right now?

Deep Throat: Riskless is very relative. The tricky part of a market like the one we have is figuring out which deals are fairly priced. Ok, that’s the tricky part of every market. But my point is that you might be more easily become overly excited in a market like this than in a much calmer market, when perhaps people with the tiny amount of capital that we have are more likely to blow their wad on stuff that’s not worth it.

In other words, look at those people on google finance who invested in Freddie and Fannie, thinking it was a riskless opportunities. Obviously, we’re not that dumb… but it’s all relative.

Cogitator: No, [REDACTED]. As I understand the English language, riskless means “without risk.” And the [REDACTED] arbitrage truly is without risk; you short sell 3.3682 shares per [REDACTED], and exercising the [REDACTED] gives you 3.3682 shares back. It’s like selling 10 apples at $1 each and getting those identical apples back for a price of only $0.93. It yielded a riskless 7% return today.

How could an investment in Fannie Mac riskless? Any directional bet is by its terms riskier than an arbitrage. Granted, the Volkswagen/Porsche incident demonstrates the risk of this technique, but that is a peculiar case. If you buy and short sell economically equivalent securities (of the same issuer) at a substantial spread (say, 30% or more), the risks should be nil.

The market is efficient most of the time for virtually all participants. However, Ackman makes a very good point: not everyone has permanent capital (capital not subject to redemption). A great deal of Buffett’s success is due to having steady access to capital at times when the rest of the world does not.

Deep Throat: “Well forget about EMH, would you agree a lot more riskless opportunities exist now than say…back in 2006?”

I was responding to the more general above statement from [REDACTED]. Not your particular case. And I didn’t believe he was *only* talking about arbitrage, though if he was, then I stand corrected.

As for the Fannie thing, I was using an exaggerated point (of stupidity) to show how recklessness even in a favorable market can get people into trouble. The point I was in particular discussing involved the discussion that [REDACTED] had linked on Google finance boards, where people were arguing, in essence, that Fannie was a riskless opportunity when at that point it was trading at 0.50$ and the government hadn’t stepped in. I was just using that to show how people were taking the idea that stuff was undervalued in the broader market and applying it to mean that investing in Fannie had no downside. And that we could make similar mistakes, so true riskless opportunities (again, outside arbitrage) did not exist.

Wild Card: I wasn’t talking only about arbitrage. I was just wondering how “highly efficient” this market really is and what makes it so highly efficient because Derek kept using that phrase.

Cogitator: Here’s what Ben Graham said about the subject:

“To the objective observer the failure of the funds to better the performance of a broad average is a pretty conclusive indication that such an achievement, instead of being easy, is in fact extremely difficult.

“Why should this be so? We can think of two different explanations, each of which may be partially applicable. The first is the possibility that the stock market does in fact reflect in the current prices not only all the important facts about the companies’ past and current performance, but also whatever expectations can be reasonably formed as to their future. If this is so then the diverse market movements which subsequently take place–and these are often extreme–must be the result of new developments and probabilities that could not be reliably foreseen. This would make the price movements essentially fortuitous and random. To the extent that the foregoing is true, the work of the security analyst–however intelligent and thorough–must be largely ineffective, because in essence he is trying to predict the unpredictable.

“The very multiplication of the number of security analysts may have played an important part in bringing about this result. With hundreds, even thousands, of experts studying the value factors behind an important stock, it would be natural to expect that its current price would reflect pretty well the consensus of informed opinion on its value. Those who would prefer it to other issues would do so for reasons of personal partiality or optimism that could just as well be wrong as right.”