Two companies combine into one entity, with shareholders of at least one side receiving cash, stock, or a mix for their shares.
Mergers require board approval, a shareholder vote described in the proxy-statement, and usually antitrust clearance. Between announcement and close the target trades below the offer price, and that gap is the market's estimate of deal risk and time value.
Once a deal is announced the target stops trading on its own fundamentals and starts trading on deal odds. Options on the target reprice sharply, since the expected path is now a step function.
Example: a target at $40 receives a $55 cash offer and jumps to $52.80. The $2.20 gap on a nine-month close is about a 4.2% return, or 5.6% annualised, which is the market pricing a real chance the deal breaks.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Risk and reward on one trade. One trade on a price scale: the entry sits 2.00 points above the stop and 6.00 points below the target, so the shaded reward band is three times the risk band. The ratio compares what is lost if the stop is hit with what is gained if the target is reached.
Educational only, not advice. Spotted an error? Post in Site Feedback.