Strategies · Library · Convertibles
§12.1Hedges and structures
Convertible arbitrage
Buy a convertible bond, which tends to be priced cheaply when issued, and short a number of the issuer's shares equal to the option's sensitivity times the conversion ratio. The hedge is revised daily. Profit comes from the cheapness and from volatility in the stock.
- Asset class
- Convertibles
- Held for
- Months
- Data
- ARCANE has part of the data
- Symphony
- Cannot be built as a symphony
The rule
- Signal
- Option sensitivity of the conversion feature to the stock price, from a pricing model.
- Entry and exit
- Open at issuance, hold roughly six to twelve months, update the share short each day.
- Sizing
- Short shares equal to the option sensitivity times the conversion ratio.
How it fails
- Hedge ratio relies on a model
- Credit spread widening
- Short squeezes and borrow costs
Data it needs
- convertible bond prices
- stock prices
- implied volatility
- credit spread
ARCANE has stock prices but not convertible bond prices or option models.
How ARCANE uses it
Not draftable. A Call about a company's equity could note that convertible issuance often precedes hedge-fund shorting.
Needs convertible bonds, option sensitivities and a short leg.
Source: Kakushadze and Serur (2018), 151 Trading Strategies, §12.1, p. 102 of the SSRN version. Described in our words. Hedges and structures is ARCANE’s filing, not the book’s.