Reverse Convertibles are Basically Bonds with Long Delta and Short Volatility Features
A reverse convertible is basically a bond with an enhanced yield, "manufactured" by the sale of a (typically) ATM put option.
They can be Made "Exotic"
Reverse Cons can be "exoticised" by selling an "exotic" option instead of the vanilla put. For example, a down-and-in put can be specified.
Reverse Convertible As A First Step to More Complex Products
The "reverse con" is also a useful building block in structures of greater sophistry, such as the autocallable.
Why Investors who Invest in Reverse Convertibles are Considered Bullish on the Underlying
An investor in the structure is considered "bullish" since the sale of the ATM put makes the investor inherently long delta (recall that to be long delta, you can be long futures, long a call or short a put).
Why Investors who Invest in Reverse Convertibles are Considered Bearish on Volatility
As an investor, you have also sold volatility (in technical terms, you are short gamma, and short vega) through the sale of the put option.
The Most Basic "Exotic" Reverse Convertible (The "Knock-In" Reverse Convertible)
The most basic "exotic" reverse convertible is the "knock-in" reverse convertible, whereby the "bond" is enhanced by selling a down-and-in put option. The option kicks in when spot drops below a certain level.
A reverse convertible is basically a bond with an enhanced yield, "manufactured" by the sale of a (typically) ATM put option.
They can be Made "Exotic"
Reverse Cons can be "exoticised" by selling an "exotic" option instead of the vanilla put. For example, a down-and-in put can be specified.
Reverse Convertible As A First Step to More Complex Products
The "reverse con" is also a useful building block in structures of greater sophistry, such as the autocallable.
Why Investors who Invest in Reverse Convertibles are Considered Bullish on the Underlying
An investor in the structure is considered "bullish" since the sale of the ATM put makes the investor inherently long delta (recall that to be long delta, you can be long futures, long a call or short a put).
Why Investors who Invest in Reverse Convertibles are Considered Bearish on Volatility
As an investor, you have also sold volatility (in technical terms, you are short gamma, and short vega) through the sale of the put option.
The Most Basic "Exotic" Reverse Convertible (The "Knock-In" Reverse Convertible)
The most basic "exotic" reverse convertible is the "knock-in" reverse convertible, whereby the "bond" is enhanced by selling a down-and-in put option. The option kicks in when spot drops below a certain level.
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