dr doom. While it is impossible to cover all the possible scenarios, it would help you understand the floorless if you studied a number of the normal convertible debentures, namely those where the conversion occur at a "fixed" price and compare the hedging strategies used by the holders of these debentures to those of the floorless.
You write:
"Consider your example of the seller of 1 MM shares at $10, who accomplishes his
selling without driving down the price of the stock. If, for the sake of argument, the
stock then jumps to $20, the floorless would convert to as little as 1/2 MM shares."
What you somehow fail to recognize are two major factors, first floorless have a conversion ceiling (HEC's last European debenture's ceiling is $6.5/share, which was close to the price when issued, the AND ceiling is at $16.5) and that most of the short position is set up at or just above the ceiling. The second factor you fail to recognize that floorless are "look back" situation, you decide on converting by looking at the price action of the last 30 or 22 or some 45 days. That is why it is extremely rare (and I know of not one single case) for the floorless bandit to be exposed to having to convert above his short stated position. In all this I have not taken the "discount to the lowest price in the last 30 days" feature yielding an additional safety blanket.
Last, as a large investor (who has probably assigned an individual to follow up on the company, or even has a seat on the board some times), the floorless knows ahead of you and me what is coming down the pike, and thus can implement temporary strategies to exploit minor price variations, and because of its position, it can even cause run up into which to short (like in HEC near the close on Friday).
Go and read a number of the documents associated with normal (fixed conversion rate) and floorless debentures, and stop falling in love with a stock.
My own personal rule is very simple, you see a company issuing a floorless, get out. If you are inclined to short and you can borrow the shares, short it.
Zeev |
