ETF arbitrage refers to the practice where investors can, through designated ETF dealers in the primary market, use a basket of stocks to subscribe to ETF shares or redeem ETF shares into a basket of stocks with the fund management company, while also being able to buy and sell ETFs at market prices in the secondary market.

Suppose during a certain period, a component stock of an ETF plummets, causing the ETF's net asset value (NAV) to drop rapidly. However, the ETF's market price fails to keep up in time, creating a temporary price discrepancy between the two. At this point, one can choose to buy the basket of stocks underlying the ETF, subscribe to ETF shares (priced at NAV), and then sell the ETF in the secondary market (priced at market value), thereby buying low and selling high to capture the price difference.

Everything starts with ETF arbitrage trading. This trading model is quite common among domestic brokerages, and even large private equity funds engage in such trades.

In simple terms, the principle of ETF arbitrage trading is the law of one price: the same product has different prices in different markets, and profits are made by exploiting these price differences. For example, the SSE 50 ETF corresponds to a basket of stocks composed of the constituents of the SSE 50 Index (1,594.903, -6.48, -0.40%). The weights of the constituent stocks in the basket vary, and these differing weights create a conversion ratio. Investors can obtain ETF shares through this ratio, and these ETF shares can also be traded in the secondary market like stocks.

Thus, there are two sequences for ETF arbitrage. One is to purchase a basket of stocks in the stock secondary market, convert them into ETF shares at a certain ratio, and then sell the shares in the ETF secondary market. This is done under the premise that the price of the basket of stocks is lower than the ETF price, known as a premium. The other sequence is the opposite: buying ETF shares in the ETF secondary market, converting them into a basket of stocks at a certain ratio, and then selling the stocks in the stock secondary market. This is done under the premise that the ETF price is lower than the price of the basket of stocks, known as a discount.

Taking Everbright Securities' ETF arbitrage operation as an example, on the morning of August 16, arbitrage trading orders had already executed 7.27 billion yuan worth of stocks, indicating that Everbright Securities was engaging in premium arbitrage, aiming to exchange a basket of stocks for ETF shares and then sell the ETF shares.

The company announced that the strategy investment department, which caused the trouble, sold 1.85 billion yuan worth of 50ETF and 180ETF that day. By this calculation, nearly 5.4 billion yuan worth of misoperated stocks remained unaddressed. According to the aforementioned arbitrage principles, this could mean that the premium arbitrage opportunity for that day had already disappeared.