Risk Arbitrage: Merger arbitrage

Merger arbitrage

Merger arbitrage involves usually the trading of the acquiring company versus the selling company. An acquiring company can either offer its own stock or simply pay by cash. The direction of the trading depends mainly on whether the acquiring company is offering to buy the target for more than the current tradable price of the target or less. If the acquirer is offering its own stock for more value than what the acquiring company is trading for then if a trader is confident that the trade will go through he/she will short the acquiring company and buy the target company and profit from the spread closing on the completion date. If the trader anticipates the deal cancelling then the logical procedure is to buy the acquirer and sell the target. The reverse logic is also true if the acquirer is offering less than the tradable value of the target company. The reason for categorizing merger arbitrage under risk arbitrage is because the merger spread is a function of the risk and probability of the merger successfully being completed.