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Doesn't exactly sound like hedging; more gamma-trading.
Obviously, a convertible bond is a stream of known cash-flows with a stock
option attached. Selling the underlying stock is effectively stripping out
the current delta of the option. This is fine, as long as it's reasonably
easy to borrow the stock - convertibles can have long lives so you'll be
holding a stock short for some considerable time, potentially.
I know of at least one hedge fund which does this for a living; most
individuals when they trade convertibles find issues in stocks they like
then just hold the options, hoping they'll turn into a good thing & taking a
reasonable coupon in the meantime.
For anyone very bearish about stocks in general but who thinks a few
well-picked stocks might have upside, and who's not worried that interest
rates might rise, this might be a way to have some equity upside without so
much downside. But there's a price, obviously (yield on convertible is lower
to compensate for the gamma you're buying).
Rus Newton
-----Original Message-----
From: pbf [mailto:pbf@xxxxxxxxxx]
Sent: 08 May 1999 06:00
To: omega mailing list
Subject: Hedging with convertible bonds?
I've just heard about a hedging technique that buys convertible bonds
and shorts the underlying stock. I'd be interested to hear from anyone
who has experience, good or bad, with this type of trading.
-Phil in KC
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