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 $375.  The 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 $375.  The 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 $375.  The 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 $375.  The 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

Synthetic Convertible Guy

Well it is the close of the trading day on Tuesday (11/23/2010) and I have been trading pretty actively over the last several sessions.   I am very happy with the success that my strategy has produced and I am confident that the trend will continue into the foreseeable future.   

I have made several changes to my portfolio including some adjustments to old positions and I have even moved forward into some other very interesting positions.    I think that most of these positions are still "low hanging fruit" for this complex strategy but walk before we run!   The complexities of this strategy can be morphed into futures, international equities, ETF's and so on.

Here is the way that my portfolio is looking right now:
     HGSI ($24.70) - Long Apr $25 Calls, short HGSI stock and then short Dec $23 and $22 Puts
     HRBN ($15.23) - Long Mar $20 Calls, short HRBN stock and then short Dec $15 Puts
     OREX ($5.90) - Short Jan $7.5 Calls, long OREX stock and long $3 Puts
     REGN ($29.99) - Long Feb $27 Calls, short REGN stock and short Dec $29, $24 and $22.5 Puts
     VVUS ($6.21) - Long Mar $5 Calls, short VVUS stock and short Dec $6 Puts

As of the close of business today ALL of my positions were positive thus far and here is a breakdown of the account summary as of close of business today:

Opening Account Value - $200,000
Commissions - ($875.48)
Profit/Loss - $2,388.40

Ending Account Value - $201,512.92

The ending account value represents a HPR (Holding Period Return) of three quarters of a percent in just a few days of trading!!!   VERY EXCITING

www.synconvertguy.blogspot.com
Synthetic Convertible Guy

First Day's Trading

www.synconvertguy.blogspot.com

The first day's trading is in the books and I am now back to post about the activity.    All in all the overall equity markets went sideways again today with the most major US indices finishing higher for the day.   From my standpoint the fact that volatility fell again today is actually a very good indicator for my type of trading.   

Here is a list of the trades that I put on today.    I will make a spreadsheet available later that you can open and read.
     HGSI - Long April $25 Calls, Short HGSI stock and short Dec $22 Puts
     HRBN - Long March $20 Calls, Short HRBN stock and short Dec $15 Puts
     OREX - Short Jan $7.50 Calls, Long OREX stock and long Dec $3 Puts
     REGN - Long Feb $27 Calls, Short REGN stock and short Dec $22.50 Puts

Most of the positions that I put on today were pretty safe bets, with all these names having some upcoming expected activity or announcement which will create price movements.   

Opening Account Value - $200,000
Commissions - ($429.22)
Profit/Loss - ($249.10)

Ending Account Value - $199,321.68

www.synconvertguy.blogspot.com

Synthetic Convertible Bond Arbitrage - "A Primer"

The concept of synthetic convertible bond arbitrage is based on the traditional hedge fund strategy of what is called "convertible bond arbitrage".   In essence hedge fund managers will purchase a convertible bond and then hedge that fixed income instrument by short selling the underlying equity in a hedged position.  

Taking a step back it is important to understand exactly what a convertible bond really is.    A convertible bond is a fixed income instrument issued typically by a corporation which allows the company to issue debt through tradition fixed income markets and structure an instrument which is unique in its' possible conversion at (or possibly before) maturity.    Typically a fixed income instrument is one which pays a fixed rate of interest per annum and then returns the principal at maturity.   A convertible bond, however similar in structure, allows the company or the purchaser to convert the bond into shares of the company stock in lieu of the principal.   This feature could be very beneficial if the company does very well and the stock increases in price while you own the convertible bond.    If not, the company will still pay the stated interest and principal at maturity.  

Since the convertible has an embedded option to convert the bond into stock, most hedgers will utilize some forms of hedging to allow for downside protection should the stock price fall.   This strategy allows the hedgers to make a profit if the stock rises OR if the stock price falls.    SOUNDS GREAT RIGHT?

THE REAL PROBLEM - The real problem with convertible bonds is that the issuance of these instruments has drastically fallen off in recent years, mostly due to tax changes.    

WHAT IF THE ISSUANCE OF NEW CONVERTIBLES COULD BE REPLICATED?    This is where my strategy comes into play.    Stay tuned for more....

www.synconvertguy.blogspot.com

Thursday November 18, 2010

This is my initial post to my new site.    Again, my focus is entirely centered on a concept which I have dubbed Synthetic Convertible Bond Arbitrage.    As you will see from this post and all subsequent posts, I do not focus on individual stocks, ETF's or fixed income however I provide information about an entirely new strategy for investing.

Each day I will publish a new "thought" which incorporates my strategy and will post a running spreadsheet of trade information including dates, times and ongoing performance data.  

I am certain that you will find the strategy truly innovative and useful as you consider your investment portfolios.    Please remember that I am not an investment advisor and nothing in my posts should be considered as investment advice.    Any trades that you make on your own are at your own risk.

I look forward to this and hope that you will as well.