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In one of my past lives we ran one of the largest Convertible bond and
Convertible Preferred books around the street.
1. This will work if you can get the interest rebate on short sales
2. if the market breaks sharply and the convert changes its relationship to
the stock ( the common stock should be a low or non
dividend payer)
3. You HAVE to do your homework check the callable dates of the Convert if
called all premiums down to the dividend differential vanish.
4. there is a lot more and you should realize that you will be in
competition with all of the large wall street firms.
Oh yes Rus is correct on the optionablility of the conversion factor with
the main exception that there is no theta, or sigma
that acts like those on options.
----- Original Message -----
From: Rus Newton <rus@xxxxxxxxxxxxxxxxx>
To: omega mailing list <omega-list@xxxxxxxxxx>
Sent: Saturday, May 08, 1999 12:14 PM
Subject: RE: Hedging with convertible bonds?
> 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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