Sunday, November 28, 2010

The Perfect Trade? HGSI Synthetic Convertible Trade

At this point we are all aware that any upcoming potential FDA approval for pharma companies creates volatility in prices.   At this point we are ready to use this characteristic to utilize the synthetic convertible bond trade that I have been discussing.  

As I mentioned in other posts as traders we are not necessarily concerned with whether the FDA approves a drug or not however we could use this event as a great trading catalyst.   In other posts I outlined the trade profiles that we will need to put on in order to make this scenario work in our favor.   Remember however we are not trying to "guess" on the direction of the stock price swing - simply using a neutral position.   Also remember that in order to use this trading strategy you will need a margin account and the broker's authorization to short stock.

HGSI is set for a FDA hearing for potential approval for their trial drug for lupus on December 9th.   This will provide the landscape and here are the trades:

     Long Dec. $23 Calls ($2.80 Mid Bid/Ask) - 10 Contracts
     Short HGSI Stock - 700 Shares
     Short Dec. $22 Puts ($0.75 Mid Bid/Ask) - 5 Contracts

There is an extremely high probability that on or around the announcement on the 9th of December that the price of HGSI will move in one direction or another.   I have outlined the potential prices of HGSI and the estimated values of each of these positions given the appropriate move in stock price.

At a price of $22 the value of our short positions increases by $2,030, our long call positions fall by $2,000 however we still receive the premium for the short puts at $375.   The net profit is $405.

At a price of $20 the value of our short positions increases by $2,430, our long call positions fall by $2,630 however we still receive the premium for the short puts at $375The net profit is $175.  (I am taking into account that at $20 we will have our puts exercised against use thus reducing our short position to the equivalent of 200 shares).

At a price of $17 the value of our short positions increases by $3,030, our long call positions have max loss of $2,800 however we still receive the premium for the short puts at $375The net profit is $605.  (Still taking into account that our puts will be exercised against use thus reducing our short position to the equivalent of 200 shares)

Now let's take a look at the other end of the spectrum.

At a price of $27 the value of our short positions decreases by $1,470, our long call positions increase by $1,350 however we still receive the premium for the short puts at $375The net profit is $255.

At a price of $30 the value of our short positions decrease by $3,570, our long call positions increase by $4,300 however we still receive the premium for the short puts at $375The net profit is $1,050.

At a price of $32 the value of our short positions decrease by $5,670, our long call positions increase by $7,300 however we still receive the premium for the short puts at $375. The net profit is $2,005.

I imagine that at this point we can start to see the picture of what we are trying to accomplish with my strategy.    I am not trying to predict the direction of the stock moves, I am simply looking for stocks that have upcoming event that create volatility in the stock price.  

www.synconvertguy.blogspot.com

1 comment:

  1. What are your thoughts on the Dec 9th date and volatility if delayed... b/c if you don't get movement of more than 10%, you're going to lose you premiums and hopefully be able to settle up positive on the short.

    Good luck with your strategy thought... I work in a Corp Treasury dept of a bank and run our hedging positions. (Mostly Swaps, Floor and Caps) Very interest to see some more of your ideas.

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