Chinese Hedge


DEFINITION of 'Chinese Hedge'

A position that protects investors from risk, involving a short position in a convertible security and a long position in its underlying asset. The Chinese hedge looks to capitalize on mispriced conversion factors. The trader will profit when the underlying asset depreciates, diminishing the premium on the convertible security.

Also known as a "reverse hedge."

BREAKING DOWN 'Chinese Hedge'

The Chinese hedge is a type of convertible arbitrage. A convertible security, such as a bond with an option to convert into shares, sells at a premium to reflect the cost of the option. The trader hopes that the underlying asset will drop in value, making the short position on the convertible profitable. By hedging his short position through longing the underlying, the investor is protected by large appreciations.

This is the opposite of executing a "set-up hedge."

  1. Set-Up Hedge

    An arbitrage strategy involving a long position in a convertible ...
  2. Convertible Arbitrage

    A trading strategy that typically involves taking a long strategy ...
  3. Underlying

    1. In derivatives, the security that must be delivered when a ...
  4. Premium

    1. The total cost of an option. 2. The difference between the ...
  5. Convertibles

    Securities, usually bonds or preferred shares, that can be converted ...
  6. Hedge

    Making an investment to reduce the risk of adverse price movements ...
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