DEFINITION of 'Set-Up Hedge'

An arbitrage strategy involving a long position in a convertible security and shorting its underlying stock. A set-up hedge looks to capitalize on mispriced conversion factors, while isolating risk unrelated to the error. The trader will profit when the underlying asset appreciates, increasing the premium on the convertible security.

BREAKING DOWN 'Set-Up Hedge'

A set-up is a type of convertible arbitrage. A convertible security, such as a bond with an option to convert to shares, sells at a premium to reflect the cost of the option. The trader hopes that the underlying asset will rise in value, correcting the mispriced conversion factor, making the long position in the convertible profitable. By hedging his long position through shorting the underlying, the investor is protected by depreciations in the bond.

This is the opposite of executing a "Chinese Hedge".

RELATED TERMS
  1. Convertible Arbitrage

    A trading strategy that typically involves taking a long strategy ...
  2. Convertible Bond Arbitrage

    An arbitrage strategy that aims to capitalize on mispricing between ...
  3. Conversion Value

    The financial worth of the securities obtained by exchanging ...
  4. Convertible Hedge

    A trading strategy that consists of a long position in a company's ...
  5. Busted Convertible Security

    A convertible security that is trading well below its conversion ...
  6. Premium Put Convertible

    A convertible bond with an additional put feature that allows ...
Related Articles
  1. Investing

    The Wonders Of Convertible Bonds

    Ever wondered what exactly a convertible bond does? Read the features of a convertible bond and learn how important the conversion factor is to you as an investor.
  2. Investing

    Convertible Bonds: Pros And Cons For Companies And Investors

    Find out why businesses choose this type of financing and what effect this has on investors.
  3. Investing

    The Top 6 Convertible Bond Funds for 2016

    Take a look at convertible bond mutual funds that are well-positioned heading into 2016, and why investors might consider a convertible fund portfolio.
  4. Managing Wealth

    The Mandatory Convertible: A "Must Have" For Your Portfolio?

    Mandatory convertibles are a little understood security with some distinct advantages. Find out if they are right for you.
  5. Investing

    The Multiple Strategies Of Hedge Funds

    Hedge fund investors or potential investors need to understand how much risk hedge funds take in making money.
  6. Investing

    Hedge Funds Hunt For Upside, Regardless Of The Market

    Hedge funds seek positive absolute returns, and engage in aggressive strategies to make this happen.
  7. Managing Wealth

    What is Convertible Preferred Stock?

    Convertible preferred stock is preferred stock that can be converted into common stock as of a predetermined date at a specified ratio.
  8. Investing

    CWB: SPDR Barclays Convertible Secs ETF

    Read an in-depth analysis of the SPDR Barclays Capital Convertible Bond ETF, which tracks an index of high-growth potential convertible bonds.
  9. Investing

    For Maximum Market Returns, Get Creative With Hedges

    Proper hedges help to contain your losses while still allowing profits to grow.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
Hot Definitions
  1. Down Round

    A round of financing where investors purchase stock from a company at a lower valuation than the valuation placed upon the ...
  2. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  3. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  4. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  5. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  6. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
Trading Center