Buying a takeover target below the offer price to capture the remaining spread, accepting the risk that the deal collapses.
The trade earns a small, fairly predictable return most of the time and a large loss occasionally, which is a classic short-volatility payoff. The spread compensates for regulatory risk, financing risk, shareholder votes, and the time until closing.
Sizing is everything, because a broken deal usually sends the target straight back to its undisturbed price in one gap, with no chance to use a stop-loss.
Example: a target trades at $47.50 against a $50 cash offer expected to close in four months. The spread is 5.3%, or about 16% annualised. If the deal breaks the stock returns to $34, a 28% loss, so the trade needs roughly a 6-to-1 win rate to break even.
Original diagrams for the ideas on this page. Illustrative, not real market data.
The bid-ask spread. Buy orders sit below, sell orders above, and the gap between the best bid (50.01) and best ask (50.04) is the spread you pay to cross. Bar length shows the size resting at each price.Risk and reward on one trade. One trade on a price scale: the entry sits 2.00 points above the stop and 6.00 points below the target, so the shaded reward band is three times the risk band. The ratio compares what is lost if the stop is hit with what is gained if the target is reached.
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