Sainsbury's Asda merger sends shockwaves across Britain's FTSE

(Corrects name of supermarket to Asda from Aldi in paragraph 6)

* FTSE 100 up 0.25 pct

* Sainsbury (Amsterdam: SJ6.AS - news) 's surges

* Competitors Tesco, Morrisons suffer

* WPP (Frankfurt: A1J2BZ - news) jumps on Q1 results

By Julien Ponthus

LONDON, April 30 (Reuters) - British shares traded higher on Monday as the planned merger between Sainsbury's and Asda, the UK arm of Walmart, sent shockwaves through British retail stocks as investors sought to adjust to a potentially game-changing overhaul of the industry.

At 0756 GMT, Britain's FTSE was up 0.25 percent at 7521.18 points but all eyes were on Sainsbury's shares, which surged up to 20 percent and were set for their highest ever rise.

"Traders will be bracing themselves for volatility in the retail sector and particularly in Sainsbury when markets open this morning," London Capital Group said in a research note.

"Given that shorting retailers has been a huge trade over the past two years, news of potential tie up between Sainsbury, the UK’s 2nd biggest supermarket and 7th most shorted stock, and Walmart subsidiary Asda could see many caught on the wrong side of the bet in early trade on Monday," the broker explained.

Shorting a stock consists of borrowing a share, then selling it with the hope a buying it back later at a lower price and pocketing the difference.

Sainsbury and Asda confirmed a 13.3 billion pounds ($18.33 billion) deal which will create Britain's biggest supermarket group by market share, surpassing current leader Tesco (Swiss: TSCO.SW - news) whose shares tumbled 2.9 percent.

"Given its size, there is very little that Tesco (Frankfurt: 852647 - news) will be able to contemplate as a response to today's news," Jefferies analysts wrote, noting however that other players in the retail sector, such as Morrisons could decide to enter a bidding war.

"The most aggressive response by Morrisons would be a bid for Sainsbury's, a deal that would benefit from the same geographic and brand complementary that is advocated by Sainsbury/ASDA today," it said.

Morrisons was down 0.5 percent while Marks & Spencer (Frankfurt: 534418 - news) lost 0.6 percent and British online grocery retailer rose 1.8 percent.

WPP shares also stood out in early trading, rising 8.5 percent after the British advertising group reported better than expected first-quarter net sales and reiterated its full-year guidance in the first set of results to be published without founder Martin Sorrell.

Shares (Berlin: DI6.BE - news) in British business support and construction services provider Interserve (Frankfurt: 860509 - news) fell sharply, down close to 12 percent, after it said its financial performance was "extremely poor" last year, and reported a wider full-year pretax loss. (Reporting by Julien Ponthus Editing by Alison Williams)