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."

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RELATED FAQS
  1. What is a Chinese hedge?

    A Chinese Hedge is a form of arbitrage by which an investor shorts a convertible bond and buys the underlying common stock. ... Read Answer >>
  2. What is a 'busted' convertible bond?

    Learn about busted convertible bonds; these are hybrid securities with conversion prices significantly higher than the market ... Read Answer >>
  3. What is the difference between convertible and reverse convertible bonds?

    The difference between a regular convertible bond and a reverse convertible bond is the options attached to the bond. While ... Read Answer >>
  4. How do I use a premium put convertible?

    Holders of convertible bonds face all the pitfalls that traditional bondholders face - liquidity risk, interest rate risk ... Read Answer >>
  5. Where does the stock come from when convertible bonds are converted to stock?

    First, let's define convertible bonds. A unique combination of debt and equity, they provide investors with the chance to ... Read Answer >>
  6. Do convertible bonds have voting rights?

    Convertible bonds usually have no voting rights until they are converted. Even after conversion, they may not be granted ... Read Answer >>
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