A classic example of arbitrage would be this: corporation X is about to purchase corporation Y in a merger. Corporation X will pay 1 share of its stock for every 2 shares of Y’s stock. Right now X stock is trading at $15 and Y stock is trading at $25. What you do is sell (let’s say) 100 shares of X stock and buy 200 shares of Y stock. So you’ve gained $600 (for the X stock) and paid $500 (for the Y stock). You are $100 ahead, and once the merger goes through you will have no position in either stock (the 200 shares of Y stock turn into 100 shares of X stock, canceling out the shares that you sold earlier).

This is called merger arbitrage, and it’s risky because if the merger doesn’t go through then you could lose a lot of money. But note that this is the extent of your risk. If X stock and Y stock lose 90% of their value before the merger, you don’t care (as long as the merger goes through on its original terms). This is the purpose of arbitrage: to lock in profits and exclude most risks.

This is the stuff that LTCM was engaged in before it went down. But it’s not scandalous, it’s just something that can go wrong if you don’t calculate the risks correctly.