Set-Up Hedge

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. Chinese Hedge

    A position that protects investors from risk, involving a short ...
  2. Convertible Arbitrage

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

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

    The financial worth of the securities obtained by exchanging ...
  5. Market Conversion Price

    An investor's effective cost to purchase common stock when it ...
  6. Convertible Security

    An investment that can be changed into another form. The most ...
Related Articles
  1. Financial Advisors

    Worried About Stocks? Try on Convertibles

    Convertibles are a good hedge against equity market risk (if you're o.k. with losing a bit of upside potential).
  2. Options & Futures

    20 Investments: Convertible Security

    What Is It? A convertible, sometimes called a CV, is either a convertible bond or a preferred stock convertible. A convertible bond is a bond that can be converted into the company's common stock. ...
  3. Professionals

    Shares from Conversion

    Series 7 - Equities Section 3: Shares from Conversion
  4. Mutual Funds & ETFs

    3 Best High-Yielding Convertible Bond Mutual Funds (LACFX, FACVX)

    Discover an often overlooked asset class and how your portfolio can benefit from it, and learn about three of the highest-yielding options available.
  5. Mutual Funds & ETFs

    3 Best High-Yielding Convertible Bond ETFs (CWB, ICVT)

    Discover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
  6. Bonds & Fixed Income

    Leverage Your Returns With A Convertible Hedge

    Find out how you can maintain your income stream by using this type of bond strategy.
  7. Bonds & Fixed Income

    Convertible Bonds: An Introduction

    Find out about the nuts and bolts, pros and cons of investing in bonds.
  8. Mutual Funds & ETFs

    Hedge Funds: Strategies

    By Dan BarufaldiHedge funds use a variety of different strategies, and each fund manager will argue that he or she is unique and should not be compared to other managers. However, we can group ...
  9. Professionals

    Convertible Bond Mathematics

    Convertible Bond Mathematics
  10. Bonds & Fixed Income

    Introduction To Convertible Preferred Shares

    These securities offer an answer for investors who want the profit potential of stocks but not the risk.
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. Why would a corporation issue convertible bonds?

    Discover how corporations issue convertible bonds to take advantage of much lower interest rates as a result of a conversion ... Read Answer >>
Hot Definitions
  1. Return On Invested Capital - ROIC

    A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. ...
  2. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  3. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  4. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  5. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  6. Keynesian Economics

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