The Price of Orange Juice, Leverage and Arbitrage
Back when I lived in London in the mid-nineties, I used the price of orange juice as a barometer of wealth within the individual boroughs. For example, I discovered that a litre of orange juice in Mayfair cost £2.89, whereas in Fulham the same brand would only cost £1.99. Remember, these were the days when mere mortals could still afford to live in any of the so-called golden postcodes. But the point is: there was a very high correlation between the price of property and the price of orange juice. Who knew?
A couple of takeaways: for one, if I live in Mayfair but don’t want to overpay for my orange juice, I could just go to Fulham and buy it there, saving myself £0.90. But, of course, we have to take into consideration the time and cost of transport it takes to get from Mayfair to Fulham. Nowadays, it would cost £20 in a black cab to get from one place to the other. Back in the nineties it would have cost £5, but luckily there is no inflation, so this is nothing to worry about. In any event, we can safely say that there is no advantage in trying to outsmart the orange juice vendors, and the price of orange juice accurately reflects the cost of acquisition.
But, is there something else we can do to take advantage of obvious price discrepancies? The thing that amazed me after consuming much orange juice, is that there is a vast difference in taste from concentrate, to pure and freshly squeezed. And along with inflation, my tastes also graduated to the good stuff and I only wanted to drink freshly squeezed orange juice. Naturally, the price for such a rare delicacy is much higher than the stuff I was used to more than 20 years ago. But still, paying £100 in Mayfair seems about right for the market these days.
So, maybe there is an advantage to living in one borough but shopping in another after all. The price in Fulham is about three fiddy (sorry, couldn’t resist another classic line from my favourite cartoon show, “South Park”), so after deducting for transport, that leaves us with a net saving of £76.50 or, extrapolated over the course of a year, an annualised return of £27,922.50 (365 days). If we could do that several times and say buy 2 or 3 litres in Fulham at a time (maybe with money we borrow) and then sell them to our friends in Mayfair at the local price of £100, we could make hundreds of thousands of pounds in profit.
And there you have it, all of us can see an arbitrage, understand what alpha is and enjoy the benefits of using leverage. It is as simple as the price of orange juice. And before you ask yourself, why doesn’t everybody do this? They do, and that’s why the price of orange juice may not stay at £100 in one borough and £3.50 in the one next to it for very much longer. But that’s a topic for another post.