Could someone help clarify why “convertible bond arbitrage performs well in times of declining credit spreads and high stock price volatility.” If you have high stock price volatility doesn’t that mean increasing credit spreads? And also if you have declining credit spreads don’t you usually have low stock price volatility? It’s like you’re saying this strategy will do well in any scenario?
The credit spreads are on the bonds, not on the stock.
Think of a convertible bond as a combination of a bond, a put option on that bond, and a call option on a stock. Options increase in value when price volatility of the underlying increases. Bonds increase in value when their credit spreads decline.
Thanks S2000.
I understand that but its just my thought that if you have high stock price volatility, stocks may not be doing so well so the spreads on bonds would blowout in that scenario. I’m probably wrong to assume?
It’s my understanding that owning a convertible bond means you are long the bond, and you have a call option on the stock. How is there a put option on the bond? It seems like if the bond goes down, you lose money regardless of what you do because the stock will likely be going down even more.
My pleasure.
You are. Don’t do that. They’ll tell you what’s happening to the bond spreads.
When you exercise the conversion, you don’t get to keep the bond. In essence, you’re opting to sell it for stock; that option to sell is essentially a put option. (Yes, it’s a bit more complicated than that, but all I said was that it’s a good way to think about it, because you understand straight bonds, call options on stocks, and put options on bonds.)
There you go, assuming again. Stop that!
