Arbitrage is based on a simple idea; buy low, sell high. Affiliates buy traffic at a lower price (hopefully) and convert it to some form of performance,often per click or per sale.
PPC is the most familiar example of affiliate arbitrage.
Affiliate arbitrage means buying traffic - PPC, display ad traffic, or other traffic you can pay for - and send it to a page that monetizes by per click or ad revenue - in this case you buy the traffic and monetize it on your sites not by selling directly, but by activity like clicks, or rarely displaying ads (hard to monetize if you are driven by ad revenue).
Domainers and lead generation are a few who do this kind of arbitrage.
Affiliate arbitrage also involves buying traffic and converting it to a purchase or other form of CPA offer, so the float between what you pay for the ad and what the result is generates more than what you paid.
In practice, much of affiliate marketing involved in buying traffic is a game of arbitrage, how much it costs you to drive traffic must be less than how much you generate.
1. Affiliate X pays Facebook $1.00 per click.
2. Affiliate X buys 5 clicks from Facebook for $5.00
3. Affiliate X sends those 5 clicks to an affiliate offer that pays $5.00 per lead.
4. If 1 out of 5 people convert (fill in lead form), affiliate X is breaking even.
For a profitable arbitrage campaign, affiliate X must do one of the following:
1. Negotiate a higher payout.
2. Reduce the cost of the clicks.
3. Increase the conversion rate.
The difference between traffic cost and the payout = profit.