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Strategies & Market Trends : Lessons Learned

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From: Don Green2/15/2023 7:47:23 AM
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It's a Trap! Why You Shouldn't Bet Against the Price Difference in AMC Stock and APE SharesDespite the price differences between AMC's common and preferred shares, using an arbitrage trading strategy could be too risky. Here's why.
Bernard ZamboninFeb 14, 2023 5:39 AM EST
AMC Preferred Equity (APE) units are currently trading for a few dollars lower than AMC Entertainment's common stock.Many traders — including Jim Chanos — are betting that AMC shares will plunge to meet the value of the APE units.It is possible that APE will rise to match the price of AMC stock, rather than AMC falling to match APE units.
Figure 1: It's a Trap! Why You Shouldn't Bet Against the Price Difference in AMC Stock and APE Shares

Noam Galai | Credit: WireImage

Read also: Why AMC Stock Might Be Ready for Another Short Squeeze

What Is the AMC/APE Arbitrage Strategy?Ever since the creation of AMC Entertainment's ( AMC) - Get Free Report preferred shares — the AMC Preferred Equity (APE) units — many traders have been using an arbitrage strategy. This involves exploiting the price difference between the two.

After all, theoretically, AMC and APE should be trading at the same price because they share the same underlying assets.

But APE shares have been trading around $2, reaching $3 in January. At the same time, AMC shares have been trading around $5, reaching $6.80 in the first week of February.

Famed short-seller Jim Chanos is among the many traders who have employed an arbitrage bet. A few months ago, he revealed that he had a short position in AMC while "going long" APE.

In a nutshell, he's betting that AMC shares will come down to APE's level. However, Chanos' AMC strategy has not yet paid off.

Why an AMC Arbitrage Strategy Is a Bad IdeaThe AMC/APE arbitrage trade isn't as simple as it looks.

That's largely because AMC is a meme stock that doesn't behave as it should.

The high volatility levels in the stock cause it to trade with zero correlation to the theater chain's business fundamentals. And that keeps the stock trading in a dissimilar pattern to the APE units.

In addition, betting against AMC shares and going long APE has been complicated by high borrow fees for traders who want to open short positions in AMC.

JonesTrading's arbitrage expert, Cabot Henderson, said that if AMC wasn't so unpredictable, shorting the stock and going long APE would be a guaranteed successful trade.

"If you can get stable borrow [fees], it's a home run. But that's the problem," Henderson said.

According to the strategist, the risk of a short squeeze makes the arbitrage trade in AMC extremely unpredictable: "The real question for 'arbs' is about how to hedge these positions, given the potential for a massive short squeeze."

What to Do InsteadThere's no logical reason why APE units are lagging behind AMC stock.

Since the APE units were created in August 2022, they have not even come close to matching the share price of AMC's common shares.

The most natural thing would be for the prices of both equities to balance out sooner or later.

But because meme stocks defy market logic, shorting AMC can be a very risky trade.

Traders who wish to bet against the theater chain's shares must pay borrow fees of over 160%, which is very high. See below:

Figure 2: AMC's borrowed shares.

Stocksera, data by Interactive Brokers

If AMC stock experiences any sharp upward movements in price — as we've seen with short squeezes — short sellers will be forced to cover their margins and lose money on these very high fees.

In theory, the safer strategy is to bet that the APEs will rise in price to match the common shares, rather than the opposite. Investors can do that by skipping a short position in AMC and just going long APE.

(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)
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