Risk arbitrage trading is a popular trading strategy in times of takeovers involving publicly traded companies. Assume company ABC shares are trading at $30 a share in the market. Upon the close of the market, it emerges that company XYZ has placed a takeover bid that values ABC at $36 a share.

The offer, in this case, represents an 18% premium to company ABC closing price the previous day. The fact that there is always a risk of such a deal going through due to regulatory challenges, political issues as well as economic cycles many at times causes the price to hover close to the takeover price.

In this case, awaiting the closing of the takeover deal, ABC share price might hover around $33 to $35 price level. Besides, there is always a possibility of the price shooting up. A trader can use this market inefficiency in pricing to benefit from risk arbitrage trading.

In this case, a trader can open a trade at $33 a share. Should ABC share price shoot above $36 upon closing of the takeover deal, the trader would end up earning more than $3 in profit. The trader would also earn the $3 profit even on the share price tanking below the $33 level and the takeover bid going through.