What is Convertible Arbitrage?
Convertible Arbitrage is an interesting trading style aimed at increasing overall yield and reducing security risk. The strategy is implemented by buying the convertible bond in a company whilst simultaneously short selling the common stock. In a nut shell the trader is trying to hedge the stock risk whilst still being paid a coupon for holding the convertible bond. Quite an effective strategy however it is important to keep note of dividends (if shorted stock then the short position is subject to paying the dividend), the prospectus and call features of the bond as these may have an impact on the hedge capability.
A. Convertible arbitrage is the practice of investing in convertible securities and then short selling the underlying common stock. Using this technique, an investor seeks to enhance income, and to hedge (or reduce) equity market risk. Short selling involves borrowing a stock and then selling it. Short sellers believe the value of a stock will drop after it is sold. In a successful short sale, the price of the stock drops after the short seller has sold it. The short seller then purchases the stock at this lower price, and returns these less expensive shares to the lender.
Convertible arbitrage is one type of investment approach that involves two simultaneous moves on investment options with a given company. Often, the most common approach to a convertible arbitrage will mean assuming a long position on a convertible security issued by the company, while at the same time assuming a short position on the underlying common stock. The purpose of the use of convertible arbitrage is to take advantage of a market situation where there is a perception that the securities are priced lower than conditions merit. The implementation of a convertible arbitrage begins with buying convertible securities. These convertible securities may be in the form of a bond issue, but offer the chance to convert the bond into shares of common stock at some future point. Buying the convertible securities places the investor in a position to hold on to the security as is, or take advantage of a conversion at a pre-determined price in the event there is anticipation that the stock wi
