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Rus, you've summed up most of the technique in a few paragraphs.
Actually, the approach I'm looking at plays off volatility, and is
moderately bullish, with downside protection (that you pay for, of
course). I'd be interested to find out the name of the hedge fund you
mentioned. Thanks!
-Phil in KC
Rus Newton wrote:
>
> 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
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