No. of Recommendations: 1
As I mentioned in a previous thread, last week I went long the debt and short the common of five corporate bond issuers.

Five market days later, I’m up modestly on the shorts (5.89%), down hugely on the bonds (-10.33%), but still collecting the coupons (12.4%), which is the reason I put the trade on, even though, really, it is an ‘investment’ in every sense of that word and not a ‘trade’ in the ordinary sense of that word. But no matter what you call it, the gig is looking good.

The real test will come, of course, when the Chapter 11 filings start happening. If I’ve done my bond entries properly, what I’ll lose on the difference between my entry and a workout will be made up by what I gain on the shorts, leaving me the coupon as my profit on the trade (-err, investment).

Viewed in that way, the trade is similar to the ‘carry trades’ that currency traders put on, or it is similar to the kinds of stuff the options guys do when they sell a call at one strike and buy a put at another. In all three cases, the intention is to hedge the downside, at the cost of capping the upside, but to end up net-profitable *and* at less risk than going just long or just short.

That’s what needs to be kept in mind. The goal of this investment (and it is an investment, not just a trade) isn’t just absolute-returns, but favorable risk-adjusted returns. Yes, return-adjusted returns spend no better at the grocery store than absolute ones. But they sure let one sleep better at night.


“I love it when a plan comes together”.
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