Traders Help - How to Long Bond using Short Stock Proceeds

jcp?

Just curious... Are you quite certain that what you're seeing are "inefficiencies in bond vs equity pricing", rather than a reflection of some feature of the market that you've overlooked?

govttrader:

You are talking about 2 separate trades

1) borrow the stock and then sell it (this is how you short stock). Note the borrow component...you must pay an interest rate to borrow something...nothing is free...and you will also be required to post margin with your broker in order to short the stock in the first place. The borrow fee can be HUGE...which generally makes shorting stock a better short term strategy as opposed to a long term strategy.

2) Buy the corp bond. Depending on the credit quality of the bond and your clearing firm / broker, the margin / capital required to buy / hold the bond will vary from 20% to 100% of the purchase price.

While this strategy may be attractive in certain circumstances...it is by no means "free." When you "short" a stock...you do not generate any "spendable" cash...you simply have a borrow of the stock...and a sale of that stock...and the resultant cash sitting in your margin acct that you CANNOT SPEND You broker / clearing firm will require *you* to post cash to margin the short position (not just the interest rate..your broker will set a margin rate for you...and that margin rate varies by broker / customer). Yes, your broker makes money when you short stock...why do you think the business exists in the 1st place? Also, the brokers generally do not allow you to take naked risk..they require you to hold funds in your acct to offset any potential losses..ever hear of "margin calls" ??

**copied from TradeKing**

Margin Requirements - You must hold in your account 100% of the security’s current market value. This is the cash you received from the initial short sale plus any increase which may have occurred to date. Because there is a liability attached to the receipt of the cash, you are not entitled to spend it. On top of that, there are standard margin requirements for short-stock transactions. However, TradeKing has the right to require higher amounts. Here’s a breakdown.

You already know you must hold the security’s entire market value. On top of that you must also hold 50% of the initial value of the short stock in cash and / or marginable securities if the strategy doesn’t go your way. That means you’ll typically need to have the equivalent of 150% of the stock’s value on hand at any time to help cover your risk. You are also subject to maintenance requirements throughout the life of the trade (usually at least 40% of the current value).

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So, net/net...your idea of using the proceeds of the short stock sale to fund the purchase of the corp bond is a no-go. You will effectively need the cash = to the full value of the stock in your account before you can initiate the short (and you can't spend that cash while you hold the short stock position)...and you will then need the full margin / regulatory capital to fund the purchase of the corp bond. (note - you can probably use the corp bond to fulfill the additional 50% of cash / margin-able securities requirement for holding the short stock position..the bonds are usually marginable securities...of course you needed to have the capital in your acct to buy the corp bond in the 1st place)

OK, agreed that the strategy cannot be implemented. What keeps stocks and bonds in check then? How would you take advantage of differences in yields under the assumption that some relationship exists between corp bond and corresponding equity.