How I Made A Low Risk $2,200 Gain in just 18 days
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Our goal with arbitrage is to minimize our holding period and to maximize our weighted average annualized return of 20% or more. This is the story of the arbitrage in the stock of Cabela’s. I recorded a podcast episode on the arbitrage of CAB that shares some more details.
This merger had already passed its last hurdle to completion before I became involved with it. Up until that point, it did not meet some of my criteria for getting involved in an arbitrage situation. Here is a list of criteria and how this arbitrage shook out BEFORE it passed the last hurdle:
- All cash consideration – PASSED - $65.50 per share in cash (later reduced to $61.50 per share)
- Big fish swallowing a little fish – FAIL – Merger of equals (CAB 85 Stores $5.5B, BASS 100 locations)
- Fair price – PASS – Paid high price to earnings, book value multiples.
- Little fish profitable and/or valuable – PASS – Years of positive earnings
- Boards approved - PASS
- Major shareholders are supportive - PASS
- No financing or abnormal contingencies – FAIL - Goldman Sachs has committed $1.8 billion and Pamplona has committed $600 million for a total preferred financing commitment of $2.4 billion announced with transaction
- Low risk of regulatory intervention – FAIL – mergers of equals can cause more scrutiny to determine if a monopoly will be created.
- Low competition for stock – FAIL – Cabela’s average daily volume was 1.3 million shares per day
- At least a 1% actual return and 20% annualized return - PASS
So before the closing date was announced, the transaction failed in too many categories for me to consider getting involved. This conservatism kept me from investing when the deal was priced at $65.50 and taking a loss when the deal was adjusted at $61.50. This is a great example of why having rules is critical to investing. Without them, you run into chaos.
The Decision to Buy into the Arbitrage
So what changed? On September 7, 2017, for those that were paying attention, Cabela’s announced that they had received the last regulatory approval they needed to close the transaction and it would close a few days after 9/21/2017 (See Key Dates below).
After reading the announcement I checked the price and CAB was selling at $60.70, almost a full dollar below the closing price. Acting quickly, I bought a block of 2,000 shares at that price. With only a few weeks before closing of the deal, I continued to buy up until 9/18.
When the dust cleared, I had acquired 6,000 shares over the two weeks. By 9/18/2017, the price had moved up to $61.39 and the arbitrage was largely over.
Taking the Position
The largest position was the initial 2,000 share purchase and that was the one that drove most of the profit. Here are the positions I took in this arbitrage:
This is what the position looks like in dollar terms:
Cost Basis ($)
As you can see, I should have bought more at $60.70. This opportunity had a fairly specific ending period and a specific price, which implies that you should buy up as much as you can prior to the closing to maximize your profit.
The proper way to analyze your return on investment for an arbitrage situation like this is to weight-average both your holding period and your annualized returns. The reason is that the positions are purchased all along the way and, therefore, the holding period becomes shorter and shorter and the annualized return can grow dramatically.
The profit in this arbitrage came mostly from the first position I took, with the other positions adding a few extra nuts and a cherry on top.
As you can see, the weighted average annualized return of 14.1% is a bit below the target of 20%, but still acceptable for what was an incredibly low risk.
9/7/17 – Approval received from final regulatory agency and announcement that transaction should close a few days after 9/21/17.
“All regulatory approvals required for the consummation of the Merger and the related transactions contemplated by the Framework Agreement, dated as of April 17, 2017, by and among the Company, WFB, Synovus and Capital One Bank (USA), National Association, a national banking association, have now been received. Pursuant to the FRB’s order, the parties cannot close the transactions earlier than September 21, 2017. The parties expect to close the transactions on or within a few days following that date. The Company expects in the near future to issue a further communication regarding the specific expected closing date.”
7/1/17 – Shareholders approve the transaction
10/3/2016 – Merger announcement
DISCLOSURE: Was long CAB until the transaction closed.
Ask JB: What is the definition of "day trading?"
submitted 9 hours ago by Sumimazen
JB Says: Great question. Let’s start by defining day trading as a brokerage sees it. FINRA has the following definitions:
FINRA defines a Pattern Day Trader as "any customer who executes four or more day trades within five business days, provided the number of day trades is more than 6% of the total trades in the account during that period".
A day trade is the purchasing and selling or the selling short and purchasing to cover of the same security on the same day (including pre- and post-market) in a margin account except for:
a. A long security position held overnight and sold the next day prior to any new purchase of the same security, or
b. A short security position held overnight and purchased the next day prior to any new sale of the same security.
Contrast this to the arbitrages I do. I may buy every single day during a short term arbitrage, but I’m not selling, so they don’t count as day trades and therefore I don’t fit the definition of “pattern day trader.”
submitted 1 day ago by DaBears50
JB Says: I love Barron's and use it to get specific kinds of ideas from the market information sections. I get the weekly one delivered on Saturday and it has everything important that that happened that week boiled down into concise articles. Check out Bloomberg Business Week as I like the long-form articles in that periodical
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