Can anyone help me clarify this?
I've been researching Conv Arb strategies, and th most common strategy I have found was long the bond, short the stock (if you think the bond is underpriced)
I would think you would want to go long on a convertible bond and put option. This way if St > conversion price, then exercise the convertible and see maximum market upside with only the cost of the puts hampering the return.
If the St conversion price, then the put can be exercised, allowing for both interest payments and put option value, right?
Too difficult? Pricey or what?
Thanks
Is St the stock price or the put strike? Not entirely sure what your question is here.
St is stock price at time of conversion
I'm just trying to understand the logic between long convert bond/short stock vs long convert bond/long put. The latter would have a strike price, k, at the conversion price
This way the premium loss on the long put hampers the upside of the convertible bond but only by the premium loss. If you short a stock and long a CB, then wouldn't the loss on the short negate all the potential upside with exception to the CB interest payments?
Sorry if it doesn't make much sense, I'm just starting out on the convertible bond arbitrage strategy
You're not wrong, but there are a few reasons you might short rather than buy a put:
a) there convexity issues, usually because convertible bonds rarely trade exactly at their parity price b) at-the-money options may be expensive (on an implied volatility basis). c) Duration on puts: your puts eventually expire and you need to buy new ones or unwind your trade
I'm not an arb guy so there may be nuances or other factors I'm missing.
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