Strategies · Library · Convertibles
§12.2Pairs and relative value
Convertible option-adjusted spread
Buy the convertible bond of an issuer with the higher option-adjusted spread and sell another of the same issuer with the lower, expecting the two spreads to converge. The spread is found by splitting price into a plain bond plus a call option and shifting the interest curve until the model matches the market price.
- Asset class
- Convertibles
- Held for
- Varies
- Data
- Needs data ARCANE lacks
- Symphony
- Cannot be built as a symphony
The rule
- Signal
- Option-adjusted spread of each convertible, found by shifting the rate curve until a model price matches the market.
- Entry and exit
- Open when the two spreads differ; close when they converge.
- Sizing
- Long one bond, short the other, roughly matched in size.
How it fails
- Spreads do not converge
- Model error in the option value
- Illiquid bonds
Data it needs
- convertible bond prices
- Treasury curve
- option pricing model
ARCANE has no convertible bond prices, curves or option models.
How ARCANE uses it
Not usable directly.
Needs bond-level data and shorting.
Filed under the pairs and statistical arbitrage card
Find two securities whose prices moved together for a year. When the gap between them opens past two standard deviations, buy the laggard and sell the leader.
A paper plan from this card holds 5 to 126 days, stops at 1.5× the expected move and uses at most 50% of your risk budget. The card
Source: Kakushadze and Serur (2018), 151 Trading Strategies, §12.2, p. 103 of the SSRN version. Described in our words. Pairs and relative value is ARCANE’s filing, not the book’s.