By shorting SDLI you're hedging your positions and basically locking in gains at no risk - if JDSU goes up, SDLI will follow, although not at the 3.8 x merger rate. You gain from JDSU, but lose some in SDLI short. However, if the merger is rejected, then I expect JDSU to soar and SDLI to plummet to pre-merger levels i.e., about $300/share. In that case, you win from both JDSU long and SDLI short and make a killing of a lifetime.
It should be noted that a lot of arbs also leverage their positions. Therefore, 19.5% return over 6 months doesn't seem like much, but the rate of return increases dramatically if they leverage their positions, for example, 3x their equity. However, if the market moves against them, they could easily get wiped out.
I think because the arbs understand the soaring levels of risk as SDLI rises artificially, they are likely to begin to unwind their positions. Also, the spread has narrowed from about 19.5% when the merger was announced to about 12% now, so they still have a gain on their positions. For them to try to capture the last 12% while taking on inordinate amount of risk is pure lunacy in my mind.
Only time will tell but I expect heavy unwinding by the arbs over the next week or so. If other traders believe in the above scenario, they may just pile on JDSU just to short squeeze the panicking arbs. |
