TRF has usually traded at a premium to its NAV ever since its inception back in 1995. However, the premium was typically around 20% above the NAV. Accordingly, I was certain that TRF's 79% premium on May 8, 2009 would likely compress in the near future. I recommended an arbitrage strategy involving selling short shares of TRF and establishing a corresponding long position in the Market Vectors TR Russia ETF (symbol: RSX). I recommended the long position in RSX because RSX tracks the benchmark DAXglobal Russia+ Index. At the time of my previous post, RSX had closed at $20.62 and TRF closed at $19.00 on Friday, May 8, 2009. Based on those closing prices, one could have generated a hedged position between RSX and TRF by selling short 2062 shares of TRF and purchasing 1900 shares of TRF.
Anyone who followed my advice should now cover the short position in TRF and sell the long position in RSX. TRF's premium has shrunk from 79% to 18%. Between the market close on Friday, May 8, 2009 and market close on Friday, October 9, 2009, TRF's NAV increased from $10.56 to $16.61, a gain of about 57.3%. However, because TRF's premium compressed substantially during the time period, the share price of TRF merely increased from $19.00 to $19.72, a gain of just about 3.8%. The share price of RSX, on the other hand, increased from $20.62 to $30.25, a gain of about 46.7%. The chart below (click on the image for a larger view) shows the performance of TRF versus RSX between May 8, 2009 and October 9, 2009.
Because the share price of RSX gained 46.7% versus a gain of just 3.8% for TRF, a substantial profit could have been made by implementing my arbitrage strategy. The long position of 1900 shares of RSX would be worth $18,292.00 more and the short position of 2062 would be worth $1,489.64 less than they were on October 8, 2009. Accordingly, summing the gain from the long RSX position and the loss from the short TRF position yields and overall gain of $16,802.36. Of course, there are trading fees and margin fees for which one needs to account. If the trades had been made through a brokerage offering low margin fees, such as Trading Direct, each trade would have cost $10 and the margin rate during the five-month period between May 8, 2009 and October 9, 2009 would have been 3.75%. The total trading fees would therefore have been $40.00 (for each purchase and sell of TRF and RSX, respectively) and the margin fees would have been about $606.*
After accounting for all trading fees and margin fees, the net overall profit would have been an impressive $16,156,36. In short, this would have been a supremely profitable arbitrage strategy!
* I calculated the margin rate over a period of approximately exactly five months between May 8, 2009 and October 9, 2009 to be 1.0375^(5/12), or 1.54574%. The total that would have been borrowed to purchase the long position in RSX would have been $39198 - the cost to purchase 1900 shares of RSX at $20.62 plus the $20 in initial trading fees to purchase RSX and sell short TRF.
