stocks and the ratio of the bidder to target shares. As in the case of a single
order, it is also possible to get a partial fill in a paired execution. In this case,
the entire specified quantity is not filled. However, the quantity of completed
shares of the bidder and the target are expected to satisfy the ratio con-
straint, and the prices of the fills must be such that the calculated spread is
greater than or less than the specified value as the case may be. Therefore,
the two important constraints that distinguish a paired transaction from a
single stock transaction are the ratio and spread constraints.
We discuss here the specification of the details of a paired transaction.
An arbitrageur specifies an order to the broker by providing the following
information.
Bidder and Target Tickers
To execute an order, we would have to know the ticker symbols of the
stocks involved.
Action
This is to signal the arbitrageur’s intention. The arbitrageur can either put
on or unwind the spread position. Notice that this implicitly sets the direc-
tion for trading the bidder and target stocks. Put onimplies that the broker
is required to sell the bidder stock and buy the target stock. Unwindrefers
to the reversal of a spread position; that is, buy the bidder stock and sell the
target stock.
Ratio and Cash Amount
The ratio and the cash amount are part of the calculation formula used to
calculate the achieved spread. We repeat the formula here for convenience.
achieved spread = price paid for bidder stock ×ratio + (10.1)
+ cash amount – price paid for targetThe Spread Value
The specification of the spread value by the arbitrageur is similar to the limit
order for a single stock. The broker should aim to match or beat the speci-
fied spread value. Now when the spread is put on, the arbitrageur would like
for the spread to be as wide as possible. In this case, the broker should aim
to achieve a spread greater than the specified value. The situation is reversed
when we unwind the spread. Here, a low value for the achieved spread is
good, and the broker should aim to get as low a spread as possible on the
execution.
Trade Execution 153