Profit Arbitrage Potential In A Closed End Fund Merger

| About: Guggenheim Enhanced (GPM)


Guggenheim Investments is merging the Guggenheim Enhanced Equity Strategy Fund, and the Guggenheim Equal Weight Enhanced Equity Income Fund, into the Guggenheim Enhanced Equity Income Fund.

The merger will close as of the open of the stock exchange on March 20, 2017.

This is a trade recommendation, not a long-term investment. I am recommending traders either arbitrage this deal, or just buy long the undervalued portion of it.

On February 13th, Guggenheim Investments announced that shareholders approved the merger of the Guggenheim Enhanced Equity Strategy Fund (NYSE:GGE), and the Guggenheim Equal Weight Enhanced Equity Income Fund (NYSE:GEQ), into the Guggenheim Enhanced Equity Income Fund (NYSE:GPM). They stated that the deal will close on March 20th, and that the merger would occur based on the relative net asset values of the funds. The deal will close in 17 days.

As usual regarding CEFs, the individual funds are grossly mispriced and are leaving on the table a large percentage gain to be made. It's as if the people trading GGE, GEQ, and GPM are not even aware of the pending closing of the deal!

Current data as of the close on March 2nd:

Stock Price NAV Discount Create GPM at
GPM 8.55 8.92 -4.15%


GGE 17.07 18.55 -7.98% 8.21
GEQ 16.71 18.26 -8.49% 8.16

GGE and GEQ are being underpriced by approximately 4% - with 17 days until closing! One reason for this is that it is hard to borrow GPM to short, and the interest charges are quite high (now 22.4%). Still with the deal so out of whack, it is worth borrowing the shares.

If one decides to buy GEQ, he would need to short 18.26/8.92 = 2.047 shares of GPM for every share of GEQ bought. He would then be creating shares of GPM at (8.92/18.26) x 16.71 (price of GEQ) = 8.16. So you are profiting by 8.55 (price GPM shorted at) - 8.16 (price GPM created at) = 39 cents. Now we have to subtract our cost of borrowing GPM which equals ((.224 x 8.55)/365) x 17 days = 8.9 cents. So your actual profit is 39 cents less 8.9 cents which equals 30.1 cents per share. this is a (30.1/8.55) = 3.52% profit over 17 days - about a 75% annualized gain.

This is a large gain for a short holding period. Of course, if you hedge the purchase of GEQ and GGE by shorting GPM, you run the risk of having to cover your short ahead of time, or having the borrow charges increase. I believe the profit potential justifies the risk on this arbitrage.

For those traders willing to take more risk, I would suggest just buying GGE and GEQ now, and sell them (you will have shares of GPM) after the deal closes. Especially those of you looking for some more "market long" exposure in this rapidly rising market.

To get an idea of the underpricing of GGE and GEQ, suppose you buy GEQ at 16.71. If it was trading in line with the stock it is going to merge with GPM, it should be trading at (18.26/8.92) x 8.55 = 17.50. That is a large underpricing. Buying GGE at 17.07 would be like owning a stock worth (18.55/8.92) x 8.55 = 17.78.

By buying shares of GGE and GEQ now, you are not only creating market exposure at a discount due to the discount of the CEFs, but add in another 4% due to the mispricing of the deal. A very interesting risk/reward trade.

I have been buying GEQ and am covering some of it with GPM short, but I am willing to hold a good amount of GEQ on its own.

Disclosure: I am/we are long GEQ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am also short GPM

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