Merger arbitrage.

In plain English

Merger arbitrage harvests the spread that remains after an acquisition is announced, collecting the difference between what the target trades for today and what the buyer has agreed to pay. The target's stock usually trades below the offer price, because the deal might not close, and that discount is the arbitrageur's potential return. In a cash deal the trade is simply buying the target. In a stock deal the arbitrageur typically buys the target and shorts the acquirer to lock in the exchange ratio. The real work is estimating the probability of closing: antitrust review, financing, shareholder votes, and the walk-away terms written into the merger agreement.

01Why it matters

The payoff is small and capped when deals close and large when they break, so a strategy that looks steady for years can give back a great deal in a single failed transaction.

02The math, step by step

An offer is $50 and the target trades at $48. That $2 spread is 4 percent, roughly 12 percent annualized if the deal closes in four months. If it collapses and the stock falls to $38, the loss is $10, five times the potential gain.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

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