Can't lose opportunity

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frostengine

I have traded options,futures, stocks etc for the better part of the last 15 years. However, I have zero bonds experience.

I believe the drop in oil prices has created a "once in a lifetime" opportunity,but I want to make sure I am not overlooking something basic to the bond market.

For example, LINE energy has several bonds trading for $3.00. First, I want to clarify what that quote really means. My understanding is that the bond is trading at 3% of par value. So, to buy a $1,000 bond it will cost you $30. If, LINE energy somehow manages to survive (doubtful) that bond could eventually trade for $100 and be worth essentially $1,000 at some point in the future. Is my understanding of the basic quoting correct?

Couldn't you do the following trade. Buy $3,000 worth of LINE bonds which equates to $100,000 par potential. Next, short 20 thousand shares of LINE common, which yields about $10,000 in cash. This $10,000 pays for the $3,000 bond investment and use the remaining $7,000 to buy LNCO 2018 $1 LEAP calls at $.10.

So to summarize you now have:
$3,000 at risk in LINE bonds with a par value of ($100,000)
Short 20 thousand shares of LINE which generated $10,000 cash
$3,000 cash set asside to cover the $3,000 bond risk
$7,000 used to purchase 2018 $1 leap calls in LNCO, which purchases about 700 options

If LINE goes bankrupt and bonds and common both go to zero, you lose $0... risk free
If LINE goes bankrupt and common goes to zero, but bonds are worth pennies on the dollar, you make some money
If LINE survives somehow and LINE goes to $1, your short shares are now down $10,000 but the bonds are worth $100,000 netting a gain of $90,000
If LINE survives and recovers to say $5 in the next 2 years, the short shares are now down $100,000 but the bond holdings are also worth $100,000 so you break even. However, the 700 option contracts you purchased are now worth around $300,000

No matter what happens, you make out like a champ in this trade. What am I missing?
 
frostengine said:
I have traded options,futures, stocks etc for the better part of the last 15 years. However, I have zero bonds experience.

I believe the drop in oil prices has created a "once in a lifetime" opportunity,but I want to make sure I am not overlooking something basic to the bond market.

For example, LINE energy has several bonds trading for $3.00. First, I want to clarify what that quote really means. My understanding is that the bond is trading at 3% of par value. So, to buy a $1,000 bond it will cost you $30. If, LINE energy somehow manages to survive (doubtful) that bond could eventually trade for $100 and be worth essentially $1,000 at some point in the future. Is my understanding of the basic quoting correct?

Couldn't you do the following trade. Buy $3,000 worth of LINE bonds which equates to $100,000 par potential. Next, short 20 thousand shares of LINE common, which yields about $10,000 in cash. This $10,000 pays for the $3,000 bond investment and use the remaining $7,000 to buy LNCO 2018 $1 LEAP calls at $.10.

So to summarize you now have:
$3,000 at risk in LINE bonds with a par value of ($100,000)
Short 20 thousand shares of LINE which generated $10,000 cash
$3,000 cash set asside to cover the $3,000 bond risk
$7,000 used to purchase 2018 $1 leap calls in LNCO, which purchases about 700 options

If LINE goes bankrupt and bonds and common both go to zero, you lose $0... risk free
If LINE goes bankrupt and common goes to zero, but bonds are worth pennies on the dollar, you make some money
If LINE survives somehow and LINE goes to $1, your short shares are now down $10,000 but the bonds are worth $100,000 netting a gain of $90,000
If LINE survives and recovers to say $5 in the next 2 years, the short shares are now down $100,000 but the bond holdings are also worth $100,000 so you break even. However, the 700 option contracts you purchased are now worth around $300,000

No matter what happens, you make out like a champ in this trade. What am I missing?
More...

Sounds good in theory, but as you may know, there ain't no free lunch.
Maybe in the 70's, you could have done this kind of strategies, but now? Nope.
Too many hedge, arbitragists, HFT, insiders, etc

CM
 
You need to price a synthetic to see where you would be financing this deal. Shares are at 0.41, so much for $10K in credit.
 
20,000 (which is what I used in above example) would yield $8,200 credit. Slightly less than I projected, but still more than enough to perform the trade as outlined, just end up buying slightly less call options than the 700 mentioned above.

I am not too concerned about the shorting, and buying calls piece. That is straight forward. The bond aspect of the trade is the piece that is foreign to me. Did I detail the bond strategy correctly? For example, am I understanding how its quoted such that the $3 quoted price means it will cost me $30 for each 1,000 par value? So all I can lose on the trade is that $30, but can make $1,000 if the bond ever goes back to par? As long as my loss is truly capped at $30 per $1,000 then I feel the trade is doable... just dont want to have a gotcha related to bonds themselves that I don't understand due to being new to bonds..

Any bond experts care to chime in on that aspect of the strategy?
 
Yes. your bond risk is capped to what you paid.

Bid/offer on the bond and the option and borrow on your short will affect your returns. I suspect significantly in terms of it being a free trade. However, if the company does pull through you will make a killing.
 
LINE has zero chance of remaining solvent. Well, 3% as the bonds are essentially reflecting the probability.

Frost, price the short-synthetic out to January. That will give you a good idea of what it will take to finance the structure out to Jan17.
 
The Jan17 1.5 synthetic short is 1.23 mid. You're going to short shares at $0.27-0.30 if you can finance well. You will receive no reduction in haircut on your long bonds, but the dime LEAPS will be married (long synthetic put), reducing your margin on the short.

You're shorting at perhaps $0.17 before a nickel in commissions.
 
frostengine said:
If LINE survives somehow and LINE goes to $1, your short shares are now down $10,000 but the bonds are worth $100,000 netting a gain of $90,000
If LINE survives and recovers to say $5 in the next 2 years, the short shares are now down $100,000 but the bond holdings are also worth $100,000 so you break even. However, the 700 option contracts you purchased are now worth around $300,000

No matter what happens, you make out like a champ in this trade. What am I missing?
More...

htf are the bonds magically at Par with the shares at $1? Or even $5?
 
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