Lecture Notes: Applied Level and Convertible Bond Trading

Key Announcements

• Week 1 Buy Side Modeling: Focus on Canadian apartment REITs.
• Differences: Buy side sifts through hundreds of stocks; Sell side usually has a smaller universe.
• Gamma Trading Video: Available in the volatility folder for applied options, focusing on MicroStrategy shares.
• Upcoming Splits (January 15th):
  • Applied Analysis
  • Applied Asset Management
  • Pricing: $425 each, with discounts available for certain certifications and subscriptions.

MicroStrategy and Convertible Bonds

• Convertible Bonds:
  • Used to take advantage of volatility.
  • Often issued with low to zero percent coupons.
  • Include a call option allowing for delta hedging.
• Convertible Arbitrage:
  • Involves capital structure arbitrage—going long on senior securities and short on junior ones.
  • Focuses on exploiting volatility rather than conversion.

Convertible Bondholders' Strategy

• Gamma Trading:
  • Aim to capitalize on price movements, not the direction.
  • Delta-neutral position with positive gamma.
• Volatility Optimization:
  • High volatility allows bondholders to achieve zero percent coupons.
  • The delta of the call option changes, allowing more shares to be shorted as prices rise.

Market Efficiency and Mispricing

• Strategies:
  • Long in Bitcoin, short in MicroStrategy to exploit cross-asset arbitrage.
  • Mispricing is seen between MicroStrategy shares and Bitcoin value.

MicroStrategy Business Model

• Operational Asset: The misinformed MicroStrategy shareholder creates volatility.
• Convertible Bonds: Serve as the mechanism for structuring trades.
• Capital Structure: Senior to equity; equity is used to acquire Bitcoin as collateral.

Risks and Observations

• Volatility Risks:
  • Decline in volatility could lead to quick drops in share price.
  • Could lead to inefficiencies, causing short sellers to capitalize.
• Miscommunication: Statements made by executives may contain misinformation or "Enron-style math."

Convertible Bonds and Market Dynamics

• Volatility as a Commodity: Essential for keeping convertible bondholders engaged.
• Shareholder Effect: They face potential losses if volatility or valuation inefficiencies resolve.
• Insider Selling: Observations of frequent selling indicating lack of confidence in Delta strategies.

Recommendations

• For Traders: Understand gamma trading and volatility use in Convertible bonds; improper understanding can lead to significant losses.
• For Shareholders: Be aware of potential misinformation; understand the true nature of the game being played.