Fungible, Trading Term Definition
Understanding fungible investments and how they work
Many investors are always on the lookout for new ways to make a profit, and fungible instruments allow just such a thing through the action of arbitrage. In other words, fungible securities allow investors and speculators to buy low and sell high to make a profit.
Fungible Trading Defined
A financial instrument (such as a stock, bond or futures contract) is considered fungible if it can be bought/sold on one market or exchange, and then sold/bought on another market or exchange.
The actual meaning of the word fungible is the ability to substitute one unit of a financial instrument for another unit of the same financial instrument, like what you can do with paper money, swapping your dollar for someone else's.
In trading, fungibility implies the ability to buy or sell the same financial instrument in two or more different markets. For example, if one hundred shares of a stock can be bought on the Nasdaq in the US, and the same one hundred shares of the same stock can be sold on the London Stock Exchange in the UK, with the result being zero shares (100 bought and 100 sold), the stock is fungible.
There are many fungible financial instruments, with the most popular being stocks listed on multiple exchanges, commodities (like gold and silver) and currencies. Most physical assets are considered fungible because you can buy or sell them at various places. You can buy gold or silver at one dealer, and sell it to another dealer.
The Opportunity of Arbitrage
Fungible financial instruments are often used in arbitrage trades. Arbitrage is when a trader takes advantage of a price difference in two different markets, buying at a lower price in one market, and selling at a higher price in the other market.
Arbitrage trades are more likely to occur when a currency exchange rate is involved, as traders can spot arbitrage opportunities in the same currency very quickly, so these opportunities don't last very long.
An example of an easily-spotted arbitrage opportunity is for a stock that's listed on both the Austrian and German stock markets, and it's fungible. One market has the shares trading at 6.23 and the other has them trading at 6.27 (both priced in euros, as both countries are part of the European Union). A trader can buy the shares at 6.23 on the one exchange, and sell them at 6.27 on the other, netting 0.04 euro on each share.
It becomes more complex when a stock or other asset is priced in one currency on one exchange, and priced in another currency on another exchange. For example, there are often about 200 (the number fluctuates) companies listed on both the Canadian and US stock markets.
The stocks on the Canadian market are listed in Canadian dollars, while the same stock will be priced in US dollars on the US exchange. Since stock prices constantly fluctuate, and so do exchange rates, fungible stocks like this are more likely to have arbitrage opportunities, although it requires more effort to spot good opportunities.
Say you find a stock that trades on the US exchange, currently with an ask price of $10 and a USD/CAD exchange rate of 1.30. The example assumes this is the price an arbitrage trader can exchange capital at, which is typically a much better exchange rate than a retail trader can get from their bank.
If the best deal a trader can get is a USD/CAD rate of 1.3, then it is expected that the stock should trade at about $13 on the Canadian exchange ($10 US stock X 1.30 USD/CAD = $13 Canadian).
From second to second, there may be small discrepancies, as the currency rate changes and the stock is subject to its own price changes from buying and selling pressures. But if traders see a large enough arbitrage opportunity to make a quick profit, they will step in, helping to push the under-priced market up (by buying), and the over-priced market down (by selling), bringing the two markets back into equilibrium.
Final Word on Fungible Trading
Fungible trading works when you can buy/sell on one exchange, and sell/buy on another exchange, netting your share position to zero and netting a profit. Fungible investments create arbitrage opportunities, as discrepancies in price can develop.
These discrepancies are usually quickly brought back into equilibrium, as traders sell to the higher priced market and buy in the lower priced market.