Profiting From the Difference

Or in other words, if premium on the Spain Fund's shares falls from 25% to the average of 12.7%, then you'll have a return of more than 12% on your short trade. Meanwhile, the risk that Spanish shares will unexpectedly rise will be offset by the purchase of the ETF for protection.

"As the discount narrows, you get outperformance vis-a-vis the index fund," says Michael Porter, ETF specialist at Lipper.

Which brings us back to the important question: What's in those two baskets of stocks?

It turns out that they are very similar in composition (see chart on prior page). Seven of the top 10 holdings in the Spain Fund can be found in equivalent proportions in the Spanish index ETF. And because of the relatively limited number of stocks trading on Spanish markets, the high concentration of the two funds -- the top 10 holdings account for 70% of the assets -- lessens the chance of a single stock's performance significantly affecting one fund and not the other.

Other arbitrage opportunities might present themselves if, in a similar way, you can pair up a closed-end fund and a comparable ETF.

Porter says the closed-end Brazil Fund(BZF - Cramer's Take - Stockpickr) is a possible arbitrage play. It trades at a 13.5% discount to its NAV and there is a potential match-up in the iShares MSCI Brazil ETF(EWZ - Cramer's Take - Stockpickr). And back in Europe, he suggests investors look at the closed-end New Germany Fund(GF - Cramer's Take - Stockpickr), which is trading at a discount of 16.8%. In this case, the iShares MSCI Germany ETF(EWG - Cramer's Take - Stockpickr) would be the corresponding ETF to buy.

But before doing anything, be sure to review the underlying assets held in the two funds to make sure they are comparable. Knowing the differences between closed-end funds and exchange-traded funds might make you money, but not knowing what you are buying in any financial products will always make you a loser in the end.