Merger Arbitration Strategies and Protection

By Salvatore Bruno via

After a long period of relative quiet, market volatility has again become an issue, with investor concerns focusing on a host of matters including global trade, interest rates, and the aging of the economic cycle. Alternative investments, specifically merger arbitration strategies, are designed to provide some protection in times like these while allowing investors to maintain exposure to the market.

Merger arb strategies, a subset of event-driven alternative investments, seek to take advantage of the pricing inefficiencies in an environment isolated from current market influences that often results after an acquisition deal is announced to when it closes.

For example, ABC company announces its intent to acquire XYZ company for $100 a share. Prior to the news, XYZ is trading at $90 and subject to typical market activity; post-news, its shares jump to $99, still a dollar short of the offer price. The reason for this spread, or difference in share prices, is the risk of deal failure, or the chance that the deal won’t go through for one reason or another. Once the deal is announced, the acquisition target is usually less subject to the movements of the market, potentially creating a smoother source of returns. When the deal does close at $100 a share, the arbitrage, or potential gain, is $1 a share.

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