Convertible Bond Arbitrage

Entry Logic

• Exact Entry Trigger: A convertible bond is trading at a price that implies a volatility level (implied vol) significantly lower than the actual historical volatility of the underlying common stock.
• Confirmation: The bond is trading at a discount to its theoretical value.
• Timeframe: Real-time analysis with specialized software.
• Location Context: Not applicable.
• Market Condition: Any, but opportunities are more frequent in volatile markets.

Exit Logic

• Profit Target(s): The bond's price converges with its theoretical value.
• Scaling Out: Not applicable.
• Trailing Stop: The position is delta-hedged, so there is no traditional stop loss.
• Signal Failure: The implied volatility of the bond fails to rise, or the stock's volatility collapses.
• Opposite Signal: Not applicable.
• Time Expiration: Until the arbitrage opportunity disappears.
• Momentum Loss: Not applicable.

Stop Loss Structure

• Hard Stop: Risk is managed through a complex set of portfolio-level risk limits.
• Soft Stop: Not applicable.
• Maximum Dollar Loss: Managed by the fund's risk manager.
• Maximum Percent Loss: Managed by the fund's risk manager.
• Structural Stop: Not applicable.

Risk Management Framework

• Risk Per Trade: This is a highly sophisticated, institutional-only strategy.
• Maximum Daily Loss: Managed by the institution.
• Maximum Weekly Loss: Managed by the institution.
• Maximum Drawdown: Managed by the institution.
• R:R Requirement: The theoretical edge must be positive after accounting for all costs and risks.

Position Sizing Model

• Sizing Approach: The strategy involves buying the undervalued convertible bond and shorting a delta-adjusted amount of the underlying common stock.
• Volatility Adjustment: The entire trade is a play on volatility.
• Conviction Sizing: Not applicable.
• Scaling In: Not applicable.
• Scaling Out: Not applicable.

Trade Filtering

• Market Conditions to Avoid: Not applicable.
• Specific Setups: Focus on liquid convertible bonds and their underlying stocks.
• Instrument Requirements: Convertible bonds, common stocks.
• Time Restrictions: None.
• Chop/News Avoidance: Not applicable.

Context Framework

• Trend Direction: Not applicable. The strategy is delta-neutral, meaning it is not dependent on the direction of the stock price.
• VWAP Relationship: Not applicable.
• MA Relationship: Not applicable.
• Range Location: Not applicable.
• Higher TF Alignment: Not applicable.

Trade Management Rules

• Breakeven: Not applicable.
• Scale Out: Not applicable.
• Add Size: The delta hedge is constantly adjusted.
• Fast vs Slow Moves: The hedge must be adjusted in real-time.

Time Rules

• Optimal Window: Any time a mispricing occurs.
• Times to Avoid: Not applicable.
• Session Notes: Requires sophisticated modeling and execution systems.

Setup Classification

• A+ Criteria: A large, liquid convertible bond trading at a deep discount to its theoretical value.
• A Criteria: A standard arbitrage opportunity.
• B Criteria: A less liquid issue.
• C Criteria: Not applicable for retail.

Market Selection Criteria

• Instruments: Convertible bonds, common stocks.
• Volume/Liquidity: High liquidity is essential for maintaining the delta hedge.
• Volatility: The strategy profits from the difference between implied and realized volatility.

Statistical Edge Metrics

• Expected Win Rate: High.
• Average Win Size: Small.
• Average Loss Size: Small.
• Profit Factor: High.
• Expectancy: Positive.

Failure Conditions

• Market Conditions: A _market crash can cause credit spreads to blow out, creating large losses.
• Specific Scenarios: The model used to value the bond is incorrect, or the hedge cannot be maintained due to a short squeeze in the underlying stock._

Psychological Rules

• Mental Discipline: This is a purely quantitative strategy. Human intervention should be minimal.

Advanced Components

• Market Regime Detection: Not applicable.
• Filters: Requires a sophisticated quantitative model and access to real-time data.
• Correlation: The strategy is based on the complex relationship between the bond, the stock, interest rates, and volatility.
• MTF Alignment: Not applicable.

Location

• Where Strongest: This is an institutional, market-neutral strategy.
• Where Weakest: Not applicable for retail traders.