MicroStrategy’s aggressive Bitcoin acquisition strategy, fueled by billions in convertible note offerings, has created a unique opportunity for hedge funds engaging in convertible arbitrage. The company’s stock volatility, driven by Bitcoin’s price fluctuations and a significant premium to its Bitcoin holdings, makes its convertible notes an attractive investment for arbitrageurs.
MicroStrategy’s co-founder, Michael Saylor, has spearheaded the company’s transformation into a Bitcoin proxy, accumulating over $40 billion worth of the cryptocurrency. To finance this endeavor, MicroStrategy has increasingly relied on issuing convertible notes, raising over $6 billion this year alone. This strategy has attracted investors like Eli Pars, co-Chief Investment Officer at Calamos Advisors LLC, who sees MicroStrategy’s convertibles as a way to capitalize on the company’s inherent volatility.
Convertible arbitrage involves hedging strategies to isolate the option-like exchange feature of convertible notes. The volatility of the underlying stock, in this case MicroStrategy, directly impacts the profitability of these trades. With MicroStrategy exhibiting an average daily price swing of 5.2% compared to the S&P 500’s 0.6%, the potential for profit is substantial. Saylor himself acknowledged the stock’s volatility during an October earnings call, highlighting it as a feature of his capital raising plan.
The attractiveness of MicroStrategy’s convertible bonds is further enhanced by their relatively cheap pricing, allowing arbitrageurs to lock in potentially significant returns. As the largest issuer of convertible bonds globally this year, MicroStrategy presents a rare opportunity in terms of size and frequency of issuance. Pars notes that the implied volatility of these convertibles is significantly lower than the realized or option-implied volatility, making them an attractive investment. Other prominent holders of MicroStrategy’s bonds include Linden Advisors, Context Capital, Graham Capital, and Millennium Management.
However, this strategy is not without risks. Saylor’s approach relies heavily on Bitcoin’s continued price appreciation. A significant downturn in the cryptocurrency market could severely impact MicroStrategy’s financial position, potentially jeopardizing the value of its convertible notes. Critics like David Trainer, CEO of New Constructs LLC, warn of the potential for a “giant house of cards” scenario if the Bitcoin rally reverses.
While convertible arbitrageurs are somewhat insulated from short-term price fluctuations due to their hedging strategies, the firm’s credit profile, intrinsically linked to the volatile Bitcoin market, remains a concern. David Clott, portfolio manager at Wellesley Asset Management, points out the asymmetric downside risk if Bitcoin corrects significantly, potentially impacting the creditworthiness of the convertible notes.
Despite the inherent risks, the combination of high volatility and attractive pricing continues to draw hedge funds to MicroStrategy’s convertible bonds. As long as Bitcoin remains within a reasonable price range and volatility persists, this arbitrage opportunity may prove too compelling to ignore.
