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How to Trade the ASX-SGX Merger Proposal

The proposed takeover of the Australian Stock Exchange (ASX) by the Singapore Stock Exchange (SGX) has raised three issues from the technical chartist's perspective: regulatory hurdles, trend direction, and predator-prey dynamics.

Australia had a requirement when the ASX was floated that no single shareholder could control more than 15 percent. The proposal could also stoke nationalistic objections, creating strong political turbulence. These fundamental factors are improcreant in a takeover and they are reflected in the trend activity on the price charts.

The second factor is trend behavior. While the merger was announced only on Monday, the chart patterns of both stocks show a 'flag' behavior, which suggests that markets have anticipated the event.

ASX and SGX Stock Charts
ASX and SGX Stock Charts

The ASX chart shows with a fast run up in price and is followed by a retreat, creating the flag (See graphic). The SGX chart shows a similar flag pattern, but it is not as well developed. This suggests the impact of the takeover will be stronger on the prey – the ASX – than on the predator – SGX. For investors, it simply means ASX will provide better trading opportunities.

The predator-prey dynamics involve calculating the takeover premium. Is it better to own the target stock- the ASX prey - or the predator SGX stock?

The first step in calculating the arbitrage opportunity is to decide the number of target shares to purchase. We start the calculations with a proposed purchase of shares in ASX. The second calculation step adds the conditions of the takeover. In this case the predator is bidding for target shares at A$48.

The next set of calculations establishes what our new ASX target shares are now worth compares to the SGX predator. This needs two figures. The first is the number of predator SGX shares swapped for ASX target shares; in this case — 1-for-1. The second set of figures relates to the sweeteners. Some takeover offers provide additional incentives by way of a cash bonus or sweetener. This offer includes a 3.5 SGX shares for every ASX shares. This is an additional bonus to the profit equation and boosts the return for this arbitrage trade.

Once we collect SGX shares, we can sell these on market. The key question in the calculation is the price we expect SGX to trade at once the takeover is completed. This is a more, or less informed guess but it is a necessary step to assess the arbitrage opportunity. The suggested offer price of A$48 is below the all time ASX high near A$58 and many may choose to factors in this as a higher target offer.

For traders who feel the bid may ultimately fail, the flags point the way to profit.

Disclosure: The author holds open positions in ASX and Red Cliff Group.

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Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com. He is a regular guest on CNBC's Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.

If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.

CNBC assumes no responsibility for any losses, damages or liability whatsoever suffered or incurred by any person, resulting from or attributable to the use of the information published on this site. User is using this information at his/her sole risk.

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  • Daryl Guppy is an independent technical analyst who appears frequently on CNBC Asia.

Asia Economy