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Politics : Ask Michael Burke -- Ignore unavailable to you. Want to Upgrade?

To: cardcounter who wrote (35453)	11/6/1998 3:27:00 PM
From: Knighty Tin	Respond to of 132070

CC, Convertible Arbitrage is still a viable strategy, but its use is very limited for individuals. Most new convertible issues are either unregistered or European. These may be fine for institutions, but they are not practical for most individuals. Basically, a convert arb is a slightly bearish play. The idea is that you buy the convertible and collect the interest while shorting the stock to protect the capital downside. You also, very importantly, collect the short rebate on the short stock. The Bass Brothers were masters of this strategy in the 1980s. What you want to happen is for the stock to crash but the co. to still be solvent enough to pay convertible coupons. Which means that nearly every co. with a convert is a decent candidate for arb. The main risk is that this technique has become so popular that people pay too much for the convertible. There are all kinds of formulae that tell you how much to pay. The most simplistic is how long it takes for the interest coupon to make up for the premium, or Payback. An example: with a stock at $50 a share and no dividend, the convertible at $1000 can be converted into 15 shares and carries a 5% coupon. You will get $50 a year. Since convertibility only allows you to claim stock that is worth $750, it will take you five years of $50 interest to make up that deficit. Then there are all kinds of more sophisticated pricing models that are similar to Black-Scholes. I look at payback. But the main thing for me is the underlying issue. If I think a stock has lots of downside but is probably not going to go broke, and it has a convertible, I will then look at convert pricing for a possible arbitrage. Another strategy that I love is convertible buy and writes. You buy the convert bond and sell covered calls against it. This is a major income producing strategy and not very risky if you get your ratios correct. MB