What's the best way to use options to protect a spread in a merger arb? Assuming all cash transaction. Two collars? Seems expensive, awkward? How about two short deep ITM options, a call on the long position, a la hedging a dividend capture, and also one on a put on the short position. Is this what pros do?
1) What would have to gain with two collars? There's no arb in that. 2) Short two deep ITM calls is just short both stocks. Why would you do that? And why would you then buy a 'call on the long' and a 'put on the short'? (What long?) 3) No this is not what the pros do. If you are an options rookie - then don't begin your education with fancy-schmancy stuff looking for edges <i>that don't exist</i>. Begin with the basics so you can understand how options work and how you can use them. Mark
Sport, I'm hardly an options rookie. What I am asking is more of a options-cum-merger arbitrage question, like if I buy 1000 of a stock that's being taken over for a cash price (and short 1000 shares of the acquirer) and there is, say, a 2.8% spread, and the deal won't close for 60 days, and I want to lock in the spread, how do I hedge against the deal collapsing and sending my long stock south and my short stock north -- and arbs do hedge, presumably using options. Simply buying a put and writing a call on the stocks involved seems rather expensive for an ordinary spread in a merger. Covered calls (or puts), ATM, OTM ITM but not deep are an incomplete hedge; you would need to do a partially naked ratio write to fully hedge -- but then you would be naked short options, hardly what one would one in a deal situation. What if a new bidder makes an offer? Boom, there goes the naked option, and all of your profit and more, perhaps. So what other ways are there: If I sell an deep ITM call, as close to 1.0 delta as I can get, I presume that will hedge my long stock (the acquired company) risk, no? (Early assignment is the only risk here, I can think of.) And do the inverse on the acquirer side of the equation, using a deep ITM put with the short stock?
LOL. The more complex you make it, the more problems you'll have if you have to unwind it. a And no matter what hedge you apply, there's always going to be a scenario where it doesn't work effectively (you outlined some of the possibilities). KISS is often the better choice
This really isn't that involved, and the risks are a whole lot less than simply long or short stock, especially now a days.
There's no way to make this a risk-free arb. If there was a way then don't you think everybody would do this to lock in the spread!?
Thanks for the timeless wisdom. I didn't say it had to be risk free. After commission, spreads, slippage, brokers going out of business possibly, there is always risk, beyond the math risk. Still people do merger arbitrage all the time and hedge to reduce not eliminate the risk. It is a business. I guess no one on ET does it, though.
Sorry, I guess I didn't read your question carefully, I thought you wanted risk-free. And you welcome for the timeless wisdom!