Profitability of Option-Based Merger Arbitrage

This paper examines the profitability of option-based merger arbitrage. A simple arbitrage strategy using stock options is designed to examine the merger arbitrage profitability from 1996 to 2008. This strategy takes long position on call options of target firms and put options of acquirer firms simultaneously. The results show that the option-based arbitrage strategy is far more profitable than the stock-based arbitrage strategy. Option arbitrage grows one dollar invested in merger deals in January 1996 into more than seventeen dollars by December 2008. In contrast, stock arbitrage grows one dollar into approximately seven dollars over the same period. It is also observed that both the strategies generate significant arbitrage portfolio returns that are robust to controls of traditional asset pricing factors.