Target Stock Quantity
This piece of information in the specification is rather straightforward. Im-
plicit in the target quantity specified is also the share quantity of the bidder
stock. The bidder stock quantity may be calculated using the formula
bidder quantity = ratio ×target stock quantity (10.2)Short Sale Indicator
The short sale indicator can take values yesorno. Putting on a spread posi-
tion involves selling the bidder stock and buying the target stock. However,
if we do not own any of the bidder stock already, the only way we can put
on the spread is by selling the bidder stock short. Since this requires a short
sale, we would expect the short sale indicator to be set to yes. Similarly,
unwinding the spread involves covering the short position in the bidder with
a purchase of bidder stock and selling the target stocks that we already own.
This does not require a short sale, and we may expect the short sale indica-
tor to be set to no.
In fact, we could even go so far as to say that typically, we can expect
this flag to be set to yes when we put on the spread and to no when we un-
wind the spread. However, on occasion the arbitrageur may not have a
spread position corresponding to a particular merger in his or her portfolio.
Additionally, he or she may also happen to take the view that the merger is
unlikely to happen and may expect the spread to diverge. To participate in
such moves, the unwind order is placed first before the order to put on the
spread. This is sometimes termed as chinesingthe spread. The unwinding
in these situations involves the sale of target shares without a prior position
and would therefore be accompanied with a short sell indicator of yes.
We illustrate the order specification with an example.
Example
Bidder ticker = HWP (Hewlett Packard Company)
Target ticker = CPQ (Compaq Computers Corporation)
Action = put on
Ratio = 0.6325
Cash amount = 0.0
Spread value = $2.30
Target stock quantity = 10,000
Short sell indicator = yesLet us see what this order means. The action is to put on the spread. That
means we sell the bidder stock (Hewlett Packard) and buy the target stock
(Compaq). Also, the short sell indicator is a yes. Therefore, the sale of the bid-
der stock (Hewlett Packard) has to be a short sale. Now that we have fixed
154 RISK ARBITRAGE PAIRS