Market Neutral
Merger Arbitrage
A company agrees to be bought at a fixed price, and the stock trades a little below it until the deal closes. Buy that gap and collect it at closing, unless the deal breaks first.
Run the deal
Set the spread, the deal-break risk, and how long until the deal is expected to close, then run it. Most runs converge in small steps up to the deal price. Some gap down hard when a break event fires instead.
How it works
- The deal price is fixed, the market price isn't, quite. Once an acquisition is announced at a set price, the target's stock trades close to it but not exactly at it. That gap is the spread, and it exists because the deal isn't guaranteed to actually close.
- Buying the spread is a bet that the deal closes as announced. If it does, the stock converges to the deal price by the closing date and the spread is captured, annualized, that return can look attractive even though the per-share dollar amount is small.
- A wider spread usually means the market sees more risk, not more opportunity. Drag the spread wider and the annualized return climbs, but a wide spread on a real deal is often the market pricing in exactly the break risk this page is asking about, not free money left on the table.
- A broken deal doesn't just erase the spread, it usually erases the premium the deal added in the first place. The stock doesn't fall back to the current price, it gaps down toward whatever it would have traded at with no deal at all, which is almost always well below where the arb was entered.
Where this breaks
Small, steady wins funding one large, sudden loss
Run the deal repeatedly at a low break-risk setting. Most trials close cleanly and collect a small, boring return. Then, eventually, one doesn't, and that single loss is many multiples the size of any of the wins that funded it. That shape, frequent small gains, occasional large loss, is the defining risk of merger arbitrage as a strategy, not a flaw in any single trade.