Convertible Arbitrage

Delta-Neutral Strategy

Traditionally, hedge funds and sophisticated traders may execute a convertible arbitrage strategy:

  1. Buy the Convertible: Gain a position in the debt plus the embedded equity option
  2. Short the Underlying: If the stock price rises, the gains on the convertible’s option can offset the losses from the short position. If the stock drops, the short can offset the convertible’s equity exposure.
  3. Capture Yield: The goal is to extract a stable return from mispriced convertibles and price swings based on their implied volatility

In the case of MicroStrategy, some market participants aim to trade relationships between the convertible notes and MSTR shares. But the extreme nature of Bitcoin's volatility and MicroStrategy's repeate purchases make this a high-stakes game.

Leverage Amplification

Both the issuer (MicroStrategy) and potential traders often use leverage:

  • Issuer Leverage: By borrowing via convertible notes, they amplify exposure to Bitcoin’s price movements (both upside and downside)
  • Arbitrage Leverage: Savvy traders may borrow to expand their position in the convertible or the equity short, aiming to magnify returns from price differences and volatility swings

As volatility increases, the potential range of outcomes widens. Gains can be exponential if the trades pan out, but losses can also become overwhelming if the market moves against the leveraged position.

Key Takeaway

Flywheel Effect

If you view MicroStrategy’s stock and convertible market as a feedback loop, MegaStrategy aims to replicate — and expand on — that dynamic with an onchain flywheel. As volatile assets (like ETH) increase in value, the protocol’s treasury expands. A larger treasury can support additional debt issuance, leading to even greater potential exposure to the volatile asset.

But flywheels go both ways – if the price of the underlying asset falls, treasury value shrinks and market confidence may erode (along with demand for convertibles).