Convertible bonds, if properly strategized, can produce amazing results.

Yet, as you have aptly explained, they are also normally more secure than common stock.

So why not combine the convertible with a short sale ?

Isn’t this dangerous?
Dangerous – no. Smart thinking – yes.

Allow me to explain.

Through the joint operation of the convertible bond and the short sale, your best offense, and, defense, is a battle plan against financial loss.

A case in point is the convertible bond Ford Motor Company, 4.25% of 2036.

By combining this bond with the speculative short sale of the common stock, paradoxically, you reduce your risk.

A case in point are the returns posted on Professor Smarba’s SCOREBOARD.

This is the fruition of utilizing a ladder approach to the convertible bond.

If interested, the totally transparent results dislosed on the website, http://www.profittaker.info.

The first plan was completed with an amazing 382% annualized profit.

The second Ford plan is now operating with a 62% annualized profit.

By teaming up these two investment techniques, you’ll practically eliminate the risk of buying the convertibles alone, at the same time avoiding the usual dangers of short selling.

Working together – It works

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Essentially, if you were to purchase a bond, you would have looked up the terms of the bond offering before purchasing it and known whether it is convertible or not, if it has a sinking fund, etc.

He also said that the easiest way would be to call your support line for your discount broker and ask them where the inventory of convertible bonds is listed.

Many debentures are convertible. If you find a list of debentures, you could look up the terms of the offering and confirm – but MANY debentures that I have seen are convertible. Understand debentures are riskier than bonds due to not being secured by real assets, but rather by cashflow and credit instead. Because of this tradeoff they will have higher coupon rates than similar bonds however.

I believe you would find terms of offerings on SEDAR – I don’t know for sure – again, I just call our bond desk for all that stuff. :)

I hope this answered your question Henry…

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[...] 6. Where Does All My Money Go: How Convertible Bond Arbitrage Works I: To speak about convertible bond arbitrage first we should look individually at convertible bonds and then separately at arbitrage itself. Once we have a handle on these two distinct concepts we can then put them together and have some fun! …uh, okay maybe fun is the wrong word. Replace that with “learn how people with lots more money than us make money way too easily”. [...]

Perhaps an alternative is to have most of the money invested in equities and then a small percentage (2%?) invested in puts on the relevant indexes. I don’t know enough about puts to know if this is practical or cost efficient but from a tax perspective it would be much better than fixed income if you are in a high tax bracket. Assuming losses on the puts are capital losses then they could be applied against gains.

Who would this apply to? Well most Canadians have enough rrsp assets to shelter their desired fixed income portion but for someone who is mega rich and has most of their money outside their rrsp or for that matter someone who is doing the SM and wants to reduce the risk of their leveraged portfolio could do something like this which could lower their equity risk and maintain the tax deductibility of their loan.

FT – I nominate you to do a post on this!

I like pictures! I know they’re really time-consuming, I’ve posted Excel charts to my own blog and I know they can be a time-sink. But as the examples become more complex the pictures become more valuable. I know that the “less than hardcore” will be sitting there with their scratch pads trying to draw ABC vs. XYZ.

And as you dig deeper into complexity, you’re going to lose more and more readers who simply won’t be able to keep up without some visual aids.

Again, I know that pictures are a pain, so these are just my $0.02.

Telly, based on your comments around the blog world, you keep up with the best of them. I’m surprised that you haven’t started your own blog yet.

I say keep up the variety of posts, especially when written by knowledgable guests (such as Preet).

Mike