What is risk arbitrage?

Those with an expanded definition of "arbitrage" would point out that the investor is attempting to take advantage of a short-term price discrepancy. In an all-stock offer, whereby a fixed ratio of the acquirer's shares is offered in exchange for outstanding shares of the target, there is no doubt that risk arbitrage would be at work.

What is risk arbitrage in a stock-for-stock merger?

In a stock-for-stock merger, risk arbitrage involves buying the shares of the target and selling short the shares of the acquirer. This investment strategy will be profitable if the deal is consummated. If it is not, the investor will lose money.

What is a risk ARB?

However, the target company's stock price often remains below the announced acquisition valuation. In an all-stock offer, a "risk arb" (as such an investor is known colloquially) buys shares of the target company and simultaneously short sells shares of the acquirer.

Should you use derivatives or risk arbitrage?

A few traders also attempt to benefit by entering complex positions using derivatives. Derivatives, though, come with expiration dates, which may act as a challenge during long periods of deal confirmation. Risk arbitrage trades are usually on leverage, which greatly magnifies the profits and loss potential.