Better to sell MCDT (B shares) and replace with purchased A shares, or buy MCDTA (A shares) and avoid the B shares. Your post stated "...if you were inclined to bet against this irrationality, you could short the B shares and buy an equal number of A shares. You might not make any money but it would be impossible for you to lose any either." Impossible to lose? Not exactly:
-Shorting MCDT (the B class) while buying MCDTA (the A class) for the typical retail investor will result in a net margin debt on the A purchase with no corresponding credit for the B short. That means when the spread disappears becomes significant, as does the interest rate on funds borrowed to buy the A. If the spread takes too long a time to reverse, the interest cost would outweigh the spread gain. So far the spread has persisted from the Feb. 7, 2001 original spinoff date of MCDTA from EMC, continuously to now.
-If the price of the B climbs above its original short price, interest will be charged by the typical retail broker on this excess. The B shares sell now for about 22. Their high is about 140. There could be a huge amount of interest to pay if the A and B go up significantly.
-If margin requirements are not met, the position (or other positions used as collateral) can be involuntarily liquidated to bring the account back into compliance. Margin requirements differ from broker to broker within umbrella SEC rules, but one pretty much minimum rule of thumb margin requirement is that equity/(long position + short position) must be greater than about 30%. Because a rise in A and B together will increase the denominator, it can result in a margin call. Because the spread in percentage terms has stayed fairly constant, as the price of A and B rises, it tends to decrease the equity numerator as well, further putting pressure on the margin position and increasing the probability of a margin call.
-Shares are not currently available to borrow (call any broker). If one has set up an A/B arbitrage position and the borrowed B shares are sold or the margin account from which they are borrowed converts to a cash account or the holder of the B shares demands they be put into certificate form, the B shares shorted will have to be bought back. This is most likely to happen when the spread is greatest (and therefore demand for B to short is greatest), resulting in a loss on the position. Because it can happen without warning, one could be left with a naked long in the A. The A could fall, resulting in a loss before there is the chance to sell the A's. |
