Convertible Arbitrage

Convertible arbitrage is a trading strategy that involves taking a long position in a company’s convertible bonds and simultaneously shorting its common stock. The strategy aims to exploit pricing inefficiencies between the convertible bond, which can be converted into equity, and the stock itself. Convertible arbitrage seeks to profit from changes in the bond's value and the stock's volatility while hedging exposure to market risk through the short stock position.

Example

An investor buys a convertible bond issued by a company and shorts the company’s stock, betting that the bond’s value will increase more than the stock declines or vice versa, capitalizing on pricing inefficiencies.

Key points

• Convertible arbitrage involves going long on convertible bonds and shorting the underlying stock.

• It seeks to profit from pricing inefficiencies between the bond and the stock.

• The strategy hedges market risk through the short stock position.

Quick Answers to Curious Questions

What is the goal of convertible arbitrage?

The goal is to profit from pricing inefficiencies between a company’s convertible bonds and its stock, while minimizing market risk through short-selling.

How does the short stock position in convertible arbitrage hedge risk?

The short stock position offsets potential losses from declines in the stock price, reducing market exposure while profiting from bond-stock price differences.