Only in an ideal world, and most of us don't trade in one. In years of profitable pairs trading I had very few pleasant surprises from takeovers, despite using a model that, as Don Bright hinted at, accepted takeover risk as part of the game and adjusted risk accordingly. A combination of typical pairs trading behavior and market forces take these trades away from you. Here's how:
Pairs traders most often are expecting reversion to the mean for their profits. They target trades where price relationships have moved away from recent or historical averages by a certain amount and are expected to return to "normal". Trades must typically conform to a price model that has both a technical component (the magnitude of current price extension, for example) and a fundamental component (Market cap, measures of valuation, etc). To profit from a takeover surprise one must, obviously, be long the acquired and short a hedge against it on the day the announcement is made. (alternatively, one could be short the acquirer and make a little money, but there's more to be made long the acquired)
Takeovers, meanwhile, don't happen in a vacuum. People know when talks or negotiations are underway, and stocks move accordingly -- especially small ones. Not only does our hypothetical gift long have clear value before talks begin, reducing the probability that it's beaten down in price enough to have a streched spread relationship with a given peer, but after talks begin the price of the potential target will strengthen even if nothing obviously illegal is taking place. Where does that put us in terms of price on the announcement date? The vast majority of the time it puts us in a spread that only conforms to part of the trading model, or perhaps none of it, and therefore has been passed on, already exited, or not identified.
The reality is that, as a pairs trader, you're very unlikely to be in a takeover the right way when it occurs unless you're speculating in them. But takeover speculation is a different game -- home runs, not singles -- and if that's your thing you probably don't want, nor do you need, pairs.
As an aside, I think Don Bright paints an image of the effect of takeovers on pairs traders that is too, well, bright. Both hooked2000 and I were critical of some of his comments on the Opening Orders thread regarding a recent hotel merger, saying that his claims about how well his guys did on that seemed unlikely. He hasn't yet responded.
