Merger Arbitrage In Spread Betting

NOTE: This is a very complex strategy which has numerous complexities rendering it only practicable for the most sophisticated spread betters.    

One of the most famous trading strategies used by hedge funds is merger arbitrage. This can be a highly profitable strategy and is regularly used by hedge fund titans like Carl Icahn and John Paulson. The question is: can you carry out merger arbitrage with spread betting? The temptation is of course the allure of lower risk profits and the fact that spread betting is one of the only ways a UK retail investor can go short.

Unfortunately the answer is, in general, no. With extreme care and the willingness to take on extra risk it is technically possible to sort of do it. The fundamental problem is that in order to pull off a merger arbitrage you need to actually have the shares at hand. You should be aware that spread betters never actually own the shares in the company that they are betting on.

The way merger arbitrage works is that you buy shares in the target company (company A) and sell short the shares in the company that's doing the takeover (company B). Once the acquisition goes through you use the shares in B you get to cover your short. Your profit is the difference between the share price of A and the price that A is actually acquired at. Unfortunately, when spread betting you don't actually get the shares to close out your short - everything is settled in cash.

On the other hand it is still possible to bet on the completion of the merger but this isn't arbitrage (its just betting). If you have reason to believe that the merger will go through you can bet long and make the difference between the acquisition price and the level at which the stock is trading. If, on the other hand, you don't think the merger will happen then you can go short and hope the stock falls when the acquisition/merger fails to go through.

Its essential to grasp that the above is, of course, betting and not arbitrage. The prices that the stocks reach post merger announcement represents the probability of the merger/takeover going through and can be reasonably efficient. Hence you need to have some compelling reason why you are more likely to be right than everyone else. There are real advantages in trading and investing if you are an industry expert.