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So You Think Markets are Efficient, Think Again

Published on March 24, 2008

So You Think Markets are Efficient, Think Again

March 24, 2008

There are two schools of thought about how Mr market behaves. Efficient and Not Efficient market theory, simply. I surely don’t belong to Efficient Market Theory (EMA) school. I believe that markets are irrational time to time and can remain so sometime even for long periods.

Let me share with you a very recent example. CME (CME) last week announced that it was buying Nymex (NMX) for $9.4 billions. Under the terms of the agreement, Chicago-based CME will pay 12.5 million shares — valued at $6 billion based on the stock’s Friday closing price of $486.05. Nymex holders will receive 0.1323 Class A shares of CME Group and $36 in cash for each share outstanding.

screenhunter_02-mar-24-0027.gif Markets generally discount the company that is being acquired, reflecting the uncertainty. Attached is a simple excel model that told me the arbitrage opportunity, currently it is $8.94 almost the same price that I mentioned on OP Discussion forum after the announcement.

nmx-inefficiency-chart-mar-08.png But during the trading hours, it discounted NMX by a whopping $23 vs average $8-10. I am attaching a chart that I formulated to display the arbitrage opportunity. It is displaying NMX movement on a 2min chart. I could have used on options but by the time I could think of anything, it was all back. Check it out before and after that “irrational” period. Of course there was uncertainty in the market as well so I also booked my profit quickly.

This was my first time playing M&A, a good lesson and something to craft further before I include it in my strategy toolbox.

More to come, Profitable trading, OP

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