Stock or Option Arbitrage Trading

The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies. It provides a mechanism to ensure that prices do not deviate substantially from fair value for long periods of time.
Given the advancement in technology, it has become extremely difficult to profit from mispricing in the market. Many traders have computerized trading systems set to monitor fluctuations in similar financial instruments. Any inefficient pricing setups are usually acted upon quickly and the opportunity is often eliminated in a matter of seconds.

Let's look at an example of how a successful merger arbitrage deal works in practice:
Suppose ABC Company is trading at $40 per share when XYZ Company comes along and bids $50 per share – a 25% premium. The stock of ABC will immediately jump, but will likely soon settle at some price higher than $40 and less than $50 until the takeover deal is legally approved and closed. However, if ABC trades at a higher price than $50, then the market is betting that a higher bid will emerge.
Scenario #1
Let's say that the deal is expected to close at $50 and ABC stock is currently trading at $47. Seizing the price-gap opportunity, a risk arbitrageur would purchase ABC at $47, hold on to the shares and eventually sell them for the agreed $50 per share acquisition price once the merger is closed. From that part of the deal, the arbitrageur pockets a profit of $3 per share, or a 6% gain, less trading fees.
From the time that they are announced, mergers and acquisitions take about four months to complete. The 6% gain would translate into an 18% annualized return
Scenario #2
Another possible scenario would be for the arbitrageur to simultaneously do Scenario #1 AND also short sell XYZ stock in anticipation that its share price will fall in value. Of course, the value of XYZ may not change. However, often an acquirer's stock does fall in value. If XYZ shares do fall in price from $100 to $95, for example, the short sale would net the arbitrageur an additional $5 per share, or 5%
From the time that they are announced, mergers and acquisitions take about four months to complete. The 6% gain from target's stock and the 5% gain from the acquirer's stock together would translate into an impressive annualized return of 33% (less transaction costs) for the arbitrager

Merger Arbitrage Trade:

Berkshire Hathaway (BRK) announced that it is paying $100 per share to acquire railroad firm Burlington Northern Santa Fe (BNI). Berkshire will also take on $10 billion of Burlington Northern debt, valuing the total deal at $44 billion
The company said the deal is its biggest acquisition ever. “Our country's future prosperity depends on its having an efficient and well-maintained rail system. Conversely, America must grow and prosper for railroads to do well,” Warren Buffett said in a press release. Mr. Buffett added, “Most important of all, however, it’s an all-in wager on the economic future of the United States. I love these bets.”

Option Arbitrage Trade Details (Bull Call Spread)
Buy the April 90 strike calls
Sell the April 100 strike calls
Net debit = 8.00 or $800 risk and cost of trade
Max reward = 2.00 or $200 per contract
ROI = 25% in four months
A 75% annualized return