The end of merger talks between EADS and BAE Systems has proven profitable news for the hedge funds and arbitrage traders using a so-called "Chinese spread".
Instead of the classic merger arbitrage strategy of 'buying the prey, selling the predator', a number of hedge funds and traders did the reverse, the 'Chinese spread' in M&A jargon, buying shares in 'predator' EADS and selling stock in 'prey' BAE.
EADS stock initially fell 18 percent and BAE rose 10 percent when details of the talks surfaced in early September, largely, in the case of EADS, by concern over the deal's industrial logic and price.
With EADS stock up 8.5 percent since mid-September and BAE down 10 percent, however, such 'Chinese spread' merger arbitrage trades set up within days after the news of the talks broke out were up a lofty 18.5 percent on Wednesday.
"Most EADS shareholders were against the deal from the beginning. Most have held their long positions, and put on an arbitrage trade using their original longs in the first place," a Paris-based arbitrage trader said.
"It was easy to see that talks would fail, and it was easy to make a killing."
While the collapse in merger talks sent EADS stock up 4.1 percent and BAE Systems down 1.1 percent on Wednesday, shares in the Airbus parent remained 12 percent below levels seen in early September, with traders saying the company has lost credibility.
"The reason why EADS stock isn't popping is because of the loss of management confidence, and the view on the company as being 'tainted' since it felt it needed a merger," the Paris-based trader said.
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