How do we find the choicest morsels of opportunity? Do the best buys come in the form of the predator, or will the prey provide the best trading opportunity? The solution comes from a combination of chart analysis and trade analysis.
Takeovers provide a range of arbitrage style opportunities as market inefficiency develops as crowds become excited. These opportunities develop when we know the future price of the instrument, and are able to compare it with the current price combination. The maths is not that difficult, but using a spreadsheet makes the calculations much simpler.
There are two basic strategies. The first is a classic capital appreciation strategy. The second is a conversion strategy -- where traders buy the target shares, and hold them until the takeover is competed and they are converted into predator shares.
The classic strategy is to buy the target company because there is often a lift in the takeover offer price before the deal is concluded. If there is more than one predator chasing the target, then the probability of counter bids is increased dramatically. Many traders simply buy the target stock and wait until the final deal is settled. This is trading for capital gain.
The conversion strategy relies on buying the target shares and holding them until they are absorbed and converted into the predator shares.
We start calculations by characterizing the two players as the target and the predator. The predator makes an offer for the target shares, and may include some form of cash sweetener to make the deal more attractive. The two most important variables are the price at which the trader purchases the target shares, and the eventual value of the predator shares once the takeover is completed.