Risk Arbitrage

Risk arbitrage, also called merger arbitrage, is a strategy that tries to profit from the gap between a stock's current price and the price a company has agreed to pay for it in a merger or acquisition. When one company announces it will buy another, the target's shares usually jump toward the offer price but rarely reach it exactly, because there's still a chance the deal falls through, gets delayed, or gets renegotiated.

The typical trade is to buy shares of the company being acquired (the target) after the deal is announced, since those shares trade at a discount to the announced buyout price. If the deal is a stock-for-stock merger, where shareholders of the target will receive shares of the acquiring company instead of cash, the arbitrageur often also sells short the acquirer's stock, betting on the spread between the two rather than on the overall direction of either stock.

The word "risk" in the name is the key nuance: this is not the kind of arbitrage where you lock in a riskless profit from a price mismatch. The deal might collapse due to financing problems, antitrust objections from regulators, shareholder votes going against it, or one side simply walking away, and if that happens the target's stock can fall sharply back to where it traded before the announcement. The profit an arbitrageur is chasing is usually a small spread, so the potential loss from a broken deal is often much larger than the potential gain from a completed one.

This is a slower-moving, event-driven strategy rather than something built around minute-to-minute price action, so it sits closer to the world of hedge funds and specialized traders than to typical intraday day trading.