I've been researching an Equity Linked Security (ELKS) ticker EHP. It's tied to Intel's stock, pays a .525 dividend at maturity, and converts to .44326 shares of INTC at the maturity date of 5/7/09. From what I can tell, if I buy shares of this security, and then short Intel for the same dollar amount, I can have a virtually riskless investment in that I will collect the dividend at maturity and the shares that convert at maturity will have a gain or loss equal to the gain or loss in the corresponding short. Question is, what am I missing? Other than the risk that Citigroup can't pay at maturity... I'd appreciate any help. Thanks.
It's not as risk free as it seems. As far as I can tell, EHP is convertible to INTC IF INTC is below $16.92. Otherwise, it will return a par value of $10 per share. If you just go short on INTC and if INTC make a big jump, then your short will lose more money than your long. You'll need to dynamically hedge this thing, which means you'll be exposed to gamma risk.
My understanding of the attached piece was that if ever the equity reduced by 25% from the pricing date then the Equity Ratio is how you will be paid out, and Intel definitely declined by over 25% since then... 1) a fixed number of shares of the Underlying Equity equal to the Equity Ratio (or, if you exercise your Cash Election Right, the cash value of those shares based on the closing price of the Underlying Equity on the Valuation Date), if the trading price of the Underlying Equity any time after the Pricing Date up to and including the Valuation Date (whether intra-day or at the close of trading on any day) declines by approximately 25% or more, or
I think that's where the 16.92 strike is about; it's a contingent claim. So, to your original question about the arb, it's not really an arb.