Friday, February 24, 2012

Limits to Arbitrgage: The Dual Chesapeake Preferreds, Part II

I did a post a few weeks ago about a market inefficiency that can't be directly arbitraged: the price discrepancy between the two Chesapeake Energy convertible preferreds. If you are curious, the company has a PDF on their website with more detailed information about the various preferreds.

The NYSE listed preferred CHK-D is trading at 95.73 today. Just to be at yield parity, and ignoring the fact that conversion parity favors CHKDG, the CHKDG should be trading at (5/4.5)*95.73 = $106.36.

So, that is 23% upside from the current level just to be at yield parity!

Also, the last time that the CHK-D traded at this level was on Nov 4. The CHKDG was trading above 90 at that point.

I own the CHKDG, as it is attractive on both a fundamentals basis and incredibly cheap compared to its more liquid counterpart.

5 comments:

portland_allan said...

I own the CHK-D, as it is attractive on both a fundamentals basis and incredibly cheap compared to its more liquid counterpart.

Typo, or am I confused? CHKDG is the one trading at a discount.

CP said...

That was a typo - I fixed it.

misha said...

I'm late to this party, but that's probably good.

Is my (income-oriented) math right on this one. CHKDG trades at 65, which is conversion parity of 25.23. (65/2.5766). The Jan '13 25 call is trading at 0.83.

so I buy 100 CHKDG, sell 2.5 Jan calls. Stock goes past 25.23, I convert into 257.7 shares, 250 of which get called away from me at $25. I sell my remaining 7.7 shares at 25.23.

But I net $1.50 of option premium, (.83-.23 * 2.5), AND the interest payment of $2.50 for half a year.

so that's $4.00 on $65 for only 6 months, which is an 12.3% yield quasi-annualized.

If the preferred just sits there at 65 and I continue to write calls on the common, I get to keep the entire option premium, or 14.1%

Am I missing something?

CP said...

Not missing anything, but I actually think those calls are underpriced so I would not sell them.

misha said...

Yeah, this is for a parent's retirement account. Not so interested in capital gains and very conservative.