Closed end fund arbitrage involves the simultaneous buying and selling of closed end funds and securities in their portfolio (or related securities or options) to take advantage of price differences bewteen the market price and the net asset value per share.

Most of the my closed end fund holdings are in IRAs where short selling is not allowed, but I plan to use some of them with non-IRA money. Here are some of the arbitrage strategies that are possible:

1) Buy a closed end fund (NYSEARCA:CEF) at a large discount and sell short a similar CEF at a premium.

2) Buy a CEF at a large discount and sell short the stocks in the funds portfolio. If the CEF is highly correlated with the S&P500, you can sell short something like SPY orbuy an inverse ETFlike SH.

3) Buy a CEF (bond fund) at a large discount and sell short US T-Bond futures or a bond etf.

4) Buy a CEF (equity fund) at a large discount and sell naked calls against stocks in its portfolio or the S&P index.

5) Sell short a CEF (equity fund) at a large premium and write naked puts against its portfolio or the S&P500 index.

A current example of arbitrage 1 above would be to buy (NYSE:ADX) (14.5% discount to NAV) and to sell short CRF (75.0% premium to NAV). I wouldnt put on this arbitrage unless you are very patient, since it is possible that the CRF premium may grow even greater before it shrinks. The reason that CRF sells at such a large premium to NAV is because it pays out an annual distribution of over 12% a year and many un-sophisticated investors find this attractive, even though most of the distribution is return of capital which reduces NAV every year.

In the long run this is unsustainable, but there is no short term trigger that forces the premium to shrink. Here is the performance of CRF since 2003 based on NAV and market price:

2003 +24.95% 2004 +4.70% 2005 -1.07% 2006 (YTD 6/30) -1.62%

But the share price appreciation has been much better because investors have bid up the premium over NAV:

2003 +83.38% 2004 +13.79% 2005 -4.51% 2006 (YTD 6/30) +23.01%

Another thing to be careful about here- the short interest for CRF is high and is equivalent to about 15 days of daily volume. If the CRF premium continues rising, a short squeeze could develop.

In spite of all of the caveats, I do think this ADX-CRF arbitrage will eventually pay off, but it may take three years or longer to work out. One interesting tidbit is that CRF actually owns ADX as one of the holdings in their portfolio. The CRF fund managers apparently realize the advantage of buying CEFs at a discount even though their own fund sells at a premium.