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Strategies & Market Trends : Playing the QQQQ with Terry and friends. -- Ignore unavailable to you. Want to Upgrade?

To: Walkingshadow who wrote (469)	5/31/2005 11:52:06 AM
From: Kevin	Read Replies (1) \| Respond to of 4814

I know that not infrequently, the premium/discount on a CEF can linger for months, even years.... And it strikes me that if both the CEF and the underlying move up, eventually you could get to a point where the arbitrage would fail because the gap would get closed from the underlying moving up. Covering the short could even result in a loss if the underlying moved up faster than the CEF, right? In theory, as well as with a poor execution of the strategy, you are correct with your statements about this strategy going against you. However a HF that fully commits to squeezing that discount for a profit will do so quite aggressively (large positions) and continuously (continue throwing more and more money at it until the arb opp 'breaks' and profit is achieved). I used the Mexico Fund for a specific reason...look back at their price/NAV from the start of 2001 through early-to-mid 2002. The discount went from over 20% to approx 5%, and if you read the fund's press releases during early 2002, they announced an 'in-kind' repurchase plan. This means they were willing to buy your MXF shares back for cash OR give you the equivalent in underlying holdings...basically they just wanted certain investors out. Can you think of why? ;-) All that is in theory, and doesn't take into consideration more sophisticated arb strategies such as weighting particularly volatile issues in the underlying, or differentially weighting positions according to some other strategy It's true that you could overweight/underweight some of the individual holdings of the CEF (a firm may do it based on fundamental research from their long/short desk, as an example). Another approach would be across-the-board higher leverage in the short positions. Example...go long the CEF $500 million, but short $1.5 billion of the underlying holdings of the CEF. Hope this helps. -K