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Convertible Arbitrage: Insights and Techniques for Successful Hedging

Convertible Arbitrage: Insights and Techniques for Successful Hedging

Nick P. Calamos

ISBN: 978-1-118-04566-4

Jan 2011

304 pages



Minimize risk and maximize profits with convertible arbitrage
Convertible arbitrage involves purchasing a portfolio of convertible securities-generally convertible bonds-and hedging a portion of the equity risk by selling short the underlying common stock. This increasingly popular strategy, which is especially useful during times of market volatility, allows individuals to increase their returns while decreasing their risks. Convertible Arbitrage offers a thorough explanation of this unique investment strategy. Filled with in-depth insights from an expert in the field, this comprehensive guide explores a wide range of convertible topics. Readers will be introduced to a variety of models for convertible analysis, ""the Greeks,"" as well as the full range of hedges, including titled and leveraged hedges, as well as swaps, nontraditional hedges, and option hedging. They will also gain a firm understanding of alternative convertible structures, the use of foreign convertibles in hedging, risk management at the portfolio level, and trading and hedging risks. Convertible Arbitrage eliminates any confusion by clearly differentiating convertible arbitrage strategy from other hedging techniques such as long-short equity, merger and acquisition arbitrage, and fixed-income arbitrage.
Nick Calamos (Naperville, IL) oversees research and portfolio management for Calamos Asset Management, Inc. Since 1983 his experience has centered on convertible securities investment. He received his undergraduate degree in economics from Southern Illinois University and an MS in finance from Northern Illinois University.
Chapter 1. Convertible Arbitrage: An Overview.

Convertible Arbitrage—A Brief History.

Why Hedge with Convertibles?

Convertible Arbitrage Performance.

What About Risks?

Basics of Convertible Securities.

Risk-Reward Analysis.

Methods of Valuation.

Convertible Profile Graph.

Basics of Convertible Arbitrage.

Multiple Convertible Structures.

Appendix 1.1.

Chapter 2. Valuation.

Convertible Valuation Models.

Binomial Option Model.

Chapter 3. The Greeks.

Measures of Risk.

Delta (.).

Gamma (Γ).

Vega (v).

Theta (.).

Rho (ρ).

More on Volatility.

Chi (χ).

Omicron (ο).

Upsilon ( υ).

Phi ( φ).

Mandatory Convertible Greeks.

Chapter 4. Credit and Equity Considerations.

Credit Evaluation.

Credit Analysis and Equity Market Feedback.

Asset Value Credit Evaluation.

Cash Flow and Valuing a Business.

Business Valuation Model.

I. Cash Inflows: Capital Employed.

II. Cash Outflows: Economic Profit.

III. Cash-Inflow Model.

IV. Intrinsic Business Value.

Chapter 5. Convertible Arbitrage Techniques.

Delta Neutral Hedge (Long Volatility).

Delta Estimates versus Theoretical Deltas.

Dynamic Rebalancing of the Delta Neutral Hedge.

Delta Neutral Hedge on Leverage.

Delta Hedge—Currency Hedge Overlay.

Appendix 5.1.

Appendix 5.2.

Chapter 6. Gamma Hedging.

Capturing the Gamma in a Convertible Hedge.

Bearish Tilt Gamma Convertible Hedge.

Bearish Gamma Hedge on Leverage.

The Gamma Tilt Hedge’s Role in a Market Neutral Portfolio.

Chapter 7. Convertible Option Hedge Techniques.

Covered or Partially Covered Convertible Call Option Hedge.

Long Convertible Stock Hedge with Call Write Overlay.

Synthetic Bond—Long Busted Convertible with Call Write.

and Long Out-of-the-Money Call for Protection.

Convertible Stock Hedge—Put Purchase Provides Additional.

Downside Protection.

Convertible Hedge Call Write with Protective Long Put.

Mandatory Convertible Preferred—Stock Hedge with Call Write Overlay.

Chapter 8. Convertible Asset Swaps and Credit Default Swaps.

Convertible Asset Swaps—Extracting Cheap Options from Investment-Grade Convertibles.

The Mechanics of Convertible Asset Swapping.

Swap Hedge Setup.

Convertible Bond Credit Default Swap—Transfer Credit Risk in a Hedge.

Appendix 8.1.

Chapter 9. Non-traditional Hedges.

The Reverse Hedge.

Call Option Hedge: Monetization of a Cheap Embedded Call Option.

Stock Hedge to Capture Cheap or Free Put Options.

Convergence Hedges.

Merger and Acquisition Risk Arbitrage Trades.

Reset Convertibles (or Death Spiral Convertibles).

Capital Structure Hedge.

Distressed Convertible Hedge or Negative Gamma Hedge Opportunities.

Basket Hedging Equity Delta.

Synthetic Worksheet Hedge.

Dividend Reduction Convertible Hedge.

Trading Desk Value Added.

Trade Execution.

Appendix 9.1.

Appendix 9.2.

Take-Over Risks—An Example.

Chapter 10. Portfolio Risk Management.

Balance Sheet Leverage.

Scenario Analysis.

Hedging Systematic Risks with Index Options.

Hedging Interest Rate Risk—Yield Curve Shifts.

Hedging Volatility with Volatility Swaps.

Hedging Omicron with Volatility Swaps.

Hedging Omicron with Credit Default Swap Basket or Short Closed End Funds.

Rough Spots for Convertible Arbitrage.

Managing the Convertible Arbitrage Manager.



""...filled with in-depth insights and a wide range of convertible topics, provides a thorough explanation..."" (Financial World, January 2004)