Risk Arbitrage Simplified
Imagine you are a gambler who plays the odds. That in a nutshell sums up the essence of risk arbitrage. In a game of roulette, one option is to bet on red numbers or black numbers, which would amount to a fifty percent chance of an even payout; however, since there are two green numbers, their existence offsets the even percentage. A player who would be betting against the red or black would be playing the substantial odds of hitting green.
Translated to investment: Hypothetically, if Joe's taco shop were publicly traded at $50.00 per share, and Sam's taco shop moved to take over Joe's taco shop at a proposed $65.00 per share, this means Joe's taco shop's shares are instantly worth $65.00 per share. The game comes into play because those same shares are currently trading at only $50.00 per share, should the buyout occur. If the early trades (restricted or non-retail trades) elevate the value up to $60.00 per share, there exists the $5.00 difference. This is the entrance of risk arbitrage. The risk inheres in the chance that the acquisition may not be completed, in which case the price per share will reduce to the original $50.00 per share.
There are many factors that are in play that prevent the individual retail trader from having a chance at capitalizing on different types of arbitrage. Access to the market and the technology required to achieve up-to-the-minute details are usually considered some of the most prominent.
What will the arbitrageur look at: - Deal Structure (Merger/Tender Offer/Other..) (Cash Deal/ Stock-Swap)
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