According to investopedia.com the definition of arbitrage is "the simultaneous purchase and sale of an asset in order to profit from a difference in the price. This usually takes place on different exchanges or marketplaces."

For example, a stock that is being traded on an American index is also being traded on a European index. An investor could buy the stocks from an index where the stock is undervalued and them sells the stock short where it is overvalued making a profit from the difference.

In stock option trading, the difference arises from the underlying stock and the strike price of the option contract. The strike price is undervalued compared to the stock price at which the stock is being currently traded.

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