Tuesday, January 31, 2012

Limits to Arbitrgage: The Dual Chesapeake Preferreds

Here is a market inefficiency for you. Chesapeake Energy has two different publicly traded preferred stocks, both with a face value of $100, and both cumulative and convertible.

  • The 4.5% coupon, which is listed on the NYSE, has a conversion price of $43.91.
  • The 5% coupon trades on the pink sheets and has a conversion price of $38.81.
The second preferred has a higher coupon and a lower conversion price. You'd expect it to trade at a higher price than the first one, right?

Wrong. The lower-yielding, NYSE-listed preferred trades at roughly $90, which is a yield of 5 percent and a conversion parity of $39.52. The second preferred trades at around $80, which is a yield of 6.25% and a much lower conversion parity of $31.

There should be a total layup arbitrage here: buying the second one at a yield of 625 and shorting the first one at a yield of 500, and pocketing a 125bp yield spread plus a huge conversion premium. Except I cannot locate the NYSE listed one to short: a limit to arbitrage.

By definition, anyone who owns the first one is totally asleep at the switch. They could buy an equivalent security that yields more and has a much more attractive conversion feature.

[Note: Assuming the NYSE-listed pref is trading at the correct price and yield, the pink sheet pref should be trading at par, not 80!]

1 comment:

eahilf said...

By definition, anyone who owns the second one is totally asleep at the switch.

the first one