Strategy #0000000023 · Event-driven and special situations
Merger arbitrage
Buy the target and assess deal consideration, break price and capital at risk.
After a public deal announcement, an arbitrageur buys the target. A cash deal pays cash if completed; a stock deal may short the acquirer at the exchange ratio. Delay and failure are central risks.
A small spread carries delay and break risk; completion odds need separate estimation.
Three ways in
Understand the story. Then inspect the risk.
Start with a familiar situation, check the payoff, then test how the numbers change.
The idea · in two minutes
Jack buys a conditional promise, not a guaranteed acquisition price
An acquirer offers 105 per target share; the target trades at 100. Jack sees a five-unit spread. Rose asks how long it may take, how far the stock could fall if the deal breaks, and whether regulators or shareholders could block it.
Assume a 90% completion chance, 105 if completed and 80 after a break. At a 100 entry, expected gross P&L is 0.9×5 + 0.1×(−20)=2.5 per share before costs, time and capital usage. A lower completion probability or break price can quickly change the result.
For a stock deal, Jack also shorts the acquirer at the exchange ratio; prices, dividends and terms can change. Regulatory news, financing, votes and extensions can widen the spread. Not every wide spread is attractive.
- 交易完成If the deal closes, receive 105 after paying 100: +5.
- 交易破局If it breaks, assume the target falls to 80: −20.
- 90% 完成機率At 90% completion probability, expected gross P&L is 2.5 per share before costs, funding and time.
Illustrative research examples only. They are not live signals or a recommendation.
The mechanics · payoff and exposure
Buy the target for a cash deal; for a stock deal, hedge the acquirer using the stated exchange ratio.
P₀ is target entry price; P_deal the consideration; P_break the assumed break value; p the investor’s completion probability; TC and Funding are costs. In a stock deal k is acquirer shares delivered per target share.
Greeks: the directional intuition
- Deal probability
- Measures sensitivity to implied volatility.
- Time to close
- Measures sensitivity to implied volatility.
- Break risk
- Measures sensitivity to implied volatility.
- Hedge ratio
- Measures sensitivity to implied volatility.
Buy the target for a cash deal; for a stock deal, hedge the acquirer using the stated exchange ratio.
Practical context · published observations
Expected deal P&L: read the record with its caveats.
The chart uses the published figures or explicitly labelled study inputs below. A historical index or model replay is not the same as an investor’s realised account return.
未校準事件機率、交易時間、現金回收、融資、股息、競價和公告跳空；結果不是推薦或回測。 Source ↗ · Methodology ↗
Change assumptions and inspect the scenario
Inputs illustrate the strategy mechanics; they are not live quotes, forecasts or investment advice.
Variants · same family, different risk levers
Deal terms determine which risks the arbitrageur must carry.
Cash and stock deals use different hedges; completion models and option overlays add further assumptions.
| Related strategy | Relationship | What changes | New cost or risk |
|---|---|---|---|
| Cash merger arbitrage | Cash consideration | Buys target shares and waits for the announced cash payment. | The target can fall sharply if the deal breaks. |
| Stock-for-stock arbitrage | Exchange-ratio hedge | Buys the target and shorts the acquirer at the exchange ratio. | Terms, prices, dividends and borrow supply can change the hedge. |
| Completion-probability screen | Deal selection | Screens on regulation, hostility, financing and voting conditions. | Models can misprice rare legal or political outcomes. |
| Cash tender-offer arbitrage | Cash tender offer | Focuses on time-limited cash tender offers. | Conditions, financing and extensions can create gap risk. |
| Option-based merger arbitrage | Option overlay | Uses target calls and acquirer puts to express deal risk with less capital. | Expiry, implied volatility and liquidity complicate the payoff. |
| Deal-spread timing | Spread and crowding | Tracks spread levels and competition among arbitrage capital. | Narrower spreads reduce expected return; crowded exits can amplify moves. |
Track regulatory approval, shareholder votes, financing, termination clauses, extensions and amendments.
Read beyond the summary
References
Primary sources and research used to describe the strategy and its limits.
- 01Mitchell & Pulvino (2001), Characteristics of Risk and Return in Risk Arbitrage.research
- 02Baker & Savaşoglu (2002), Limited Arbitrage in Mergers and Acquisitions.research
- 03Mitchell, Pulvino & Stafford (2004), Price Pressure around Mergers.research
- 04Kakushadze & Serur (2018), 151 Trading Strategies, §3.16.source