And a related question, when do the bonds mature? You can't be assured that they will pay out par until they mature, even if the stock price goes up. I think the OPs original thought process is sound, but matching the tenor of the bonds with the put/short position is the key.
That's one of many problems. Another is are the bonds callable and at what price? Another issue like Sig mentioned is the cash flow symmetry. The short stock could blow him out way before he ever sees a dime on the bonds. So he will get forced to cover his stock position and then the company could still end up going under. He could lose on both ends. And I don't even want to guess what the bid/offer is on those bonds. LOL.
The assumption would be for the stock price to have recovered to $1 or $5, that the the company would have received some sort of lifeline which makes bankruptcy no longer an immediate concern. In that scenario, the bonds should appreciate significantly. As far as them being at par, I suppose they may not return to par until maturity, but if they appreciate significantly, couldn't you just sell them? As far as the short, keep in mind the short is also protected by ~700 long $1 strike calls. If the price of the underlying was to get back above $1, there is likely an area somewhere between current price and about $1.25 or so where I could be at max pain and have a decent paper loss. should not be too extreme however considering the calls are owned in about a 3 to 1 ratio with the short position. Any move over $1 would quickly become profitable purely off of the short common + call position. Whatever happens with the bonds at that point is gravy and what hopefully prevents even a temporary paper loss.
Yeah, Mav. I mentioned the synthetic assuming not only a financing forecast, but as a possible vehicle to short. Assume you're just buying the put, and subtract the three cents you receive on the call. I can't imagine those bonds are under four-bid. It's a non-starter.
They are not going to be trading near Par. There is nothing in your calcs that is remotely accurate. Zero possibility of netting over $0.15 on the short (net of LEAPS). No idea where the bonds are trading -- this shit trades "by appointment" and I am not in front of my screen. Do your DD. Obviously you'd not done enough to even approximate your financing. Obv do not short the shares... they're priced as an option anyway. You're going to pay 1.25 (best case) to buy the Jan 1.5P? An effective short of a quarter?
On the mechanics it's long a ton of upside convexity, but the math is FUBAR. Frost thinks he can short frictionless and at zero-cost. He sees the last trade at $0.42 and thinks that's his short. The first part of the process is financing -- where is the short? You price the synthetic as optimal financing is embedded in the price. You can think of the NBBO on the s/short as best and worst case financing, simply as a rough estimate. You'll quickly know enough to stop.
Yeah OK so the leap jan 1.00 puts are .95 offered. There is a nickel to be made in the trade on the options plus the loss on the bonds. This trade doesn't even have a positive expectancy much less can't lose opportunity. Frost, what destriero is trying to tell you is the 1 strike puts include your financing cost so you can approximate that leg of that trade. You are essentially shorting the stock at .05 hoping it goes to zero, that is how you value these things, through the synthetic. The long bonds are done. For one, where you got that price was probably a last traded price, not an offer. The offer is probably closer to 25!. Regardless, you can't buy them under a nickel which is what is required to be profitable. Forget the call purchase and donate some money to your brokers fav charity. The syn put has the embedded call already in the combo.
The LEAPS made no sense. Scratch the LEAPS by avoiding the 1.5C-side of the synthetic -- no short shares, no short synthetic, just long puts. You lose three cents on the call-credit, but the LEAPS are nullified. He's trying to make rain from the LEAPS and the bonds. This is silly. All locks look awesome when you ignore financing. This structure makes no money.
I just checked. According to TRACE bonds are trading between 3 and 4 and expire in 2019. So if this company isn't bankrupt by then, OP should receive par. Until then, who knows. OP, in the end, you will spend a lot to create an arbitrage position that probably won't be an arb (after costs are baked in). And Mav is right that you can have some serious MTM issues that can affect your position (stock rallies and bonds stay 3 at 15 even though fv is closer to 12). If you are bullish on this company, just buy the bonds. It will be the cleanest thing to do. Alternatively, just buy the stock. A possible scenario for the bond is that the bond holders take a haircut, get equity in the company and then company does well. Current equity holders blown out.
And the OP has to ask himself, who is going to sell their Line Bonds for $3? The answer is 50 offered.