Dissect this .......

[stock777]

http://www.fisn.com/CDalternatives.htm

The street is issuing this paper that pays a very high rate of interest 10-19 % a year, but is actually a modified bet on stock.

Whenever I analyze these I can't seem to figure out a decent hedge with options, which makes sense since they are probably marking up the existing prems big time.

Someone want to tackle this and see if theres a way to game them?

 

[sle]

I presume you are talking of fixed rate exchangables? It is a fairly straight forward equity linked note. In it's simplest case, if the stock dropped below todays level, you get stock, otherwise, you get cash + interest. In short, you are selling ATM puts for cheap, either in a simple european form:

if the Final Share Price of the exchangeable common stock is higher on the maturity date than the Initial Share Price

or in a form of american barrier:

never fallen below the protection level of the Initial Share Price during the term

Sometimes, you are selling OTM american barrier

had been below the protection level or greater during the term

Now, hedge-wise, american barriers are pretty well hedged by simple Europeans, they are long vega and long skew.

 

[stock777]

These have a protection feature by % of the stock price, that varies with the issue.

Certainly complicates analysis.

Take a look at one of them and see if you can figure out how 'cheap' you are selling the put vs the true market.

 

[sle]

Quote from stock777:
These have a protection feature by % of the stock price, that varies with the issue.

How would % of the stock price be different from the actual dollar amount given that you know the initial price of the stock? These really are straight forward, unless I am missing something - do you have a term-sheet for one of these handy?

Anyway, are you planning buy these notes and hedge them using some alternative methods?

 

[dis]

Margin requirements aside, no upside, limited downside translates into:

+u - (ATM LEAP) c + (DOTM LEAP) p
or
- (ATM LEAP) p + (DOTM LEAP) p .