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."