This is a type of arbitrage style opportunity because we know the future price of the instrument, and are able to compare it with the current price combination. The math is not that difficult, but using a spreadsheet makes the calculations much simpler.
We start calculations by characterizing the two players as the target and the predator. 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.
We start with the current cost of the target shares. The offer has been announced, and we need to decide if we buy target shares today just how profitable this may be in the future given changes in the price of predator shares. Once we know these figures we can make a better estimate about the risk of the trade.
Next we establish the conditions of the takeover. In this example the predator is offering 20 predator shares for every 100 target shares.
The next most important variable is the current price of the predator shares. This price will change over the course of the takeover. The take over conditions remain in place for an extended period while the price of the predator shares varies according to market sentiment. Traders who decide to wait and convert their target shares into predator shares need to understand the impact of these price changes on the profitability of their trade.
The assumption is that the conditions of takeover remain the same. Once the predator price drops below $12.00 in this example this strategy becomes unprofitable. It is not until the predator price, when the shares are converted, reaches more than $13.80 with a 10% return, as shown by the red lines, that this strategy becomes relatively profitable.
Predator and prey calculations allow traders to make a better judgement about the strategy they prefer to use when a takeover offer is made. It tells them which is sweeter – Kraft or chocolate.
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