CONVERTIBLE ARBITRAGE

[ajsa]

Hi David,

Could you take a look of this question for me? The answer is d. But CONVERTIBLE has long call opt, so i think (postive) gamma should not create any risk for this position, right?

thanks..

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Identify the risks in a convertible arbitrage strategy that takes long positions
in convertible bonds hedged with short positions in Treasuries and the
underlying stock.
a. Short implied volatility
b. Long duration
c. Long stock delta
d. Positive gamma

 

[David Harper CFA FRM]

Hi ajsa,

I agree with you. That's a vanilla convertible arb that is long gamma/long vega/short theta (i.e., time decay works against the long option) ... so I don't see how "positive gamma" is a risk ... i find the long/short terminology akward; e.g., a risk here does include (as an extension of being long the call option, exactly as you say) realized volatility being lower than implied volatility when entering the position, so then the risk would be "low volatility" not "short implied volatiltiy [sic]" ... but i don't understand how "short implied volatility" is a risk/risk factor per se, that's a position (??) ....David