Capital Structure Aribitradge

[laura1987]

Hi,
Is long a convertible bond; long position in put option on stock a similar firm a Capital Structure Arbitradge?
In my opinion, it is not Capital Strucutre arbitradge since in both position, you long volatility. Thus in some way, you are betting an increase in stock volatility.

Is that correct?
Thanks for any enlightened explanation for you all.

 

[David Harper CFA FRM]

Hi Laura,

That's interesting. If we follow Jaeger's definition (some thoughts here) of capital structure arb, i think it amounts to: a simultaneous and non-directional (or convergence) trade on components of capital structure.

in this case: convertible bond + long put = (long bond + long option) + long put

so, I agree with you the combination of embedded option and long put, by itself, does not appear to be capital structure arbitrage; as you say, long option + long option = long volatility

however the long bond + long put does quality as capital structure arb
(to confirm, note it's similarity to answer A in this question: http://forum.bionicturtle.com/viewthread/1428/)

so, my *opinion* is you have three positions and a *partial* capital structure arb

David