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Strategies & Market Trends : Lessons Learned

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From: Don Green7/29/2023 10:03:53 AM
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AMC-APE Bet Has Handed 150% Gains — and 260% Losses — to Traders


(Bloomberg) -- A seemingly sure-thing bet on AMC Entertainment Holdings Inc. shares has turned out to be anything but, as some traders appear to have more than doubled their money, while others lost over 250%, in just a few months.

The wide range of possible outcomes in the so-called arbitrage trade underscores a truism in these kinds of wagers: timing is everything. An analysis from data firm S3 Partners shows that simply shifting the start date of the trade by one month made the difference between losing nearly 200% — possible when leverage is involved — and gaining more than 100%.

AMC-APE Bet Possible Outcomes |
Investors in the trade are buying the company’s relatively cheap preferred shares, while selling the common shares short, betting that preferreds will be converted into ordinary stock. Over time, if AMC’s plan is successful, arbitrageurs could see profits.

But so far for hedge fund managers and other investors, this meme stock has offered a wild ride. The potential results vary so much in part because the gap between the securities in the trade has fluctuated wildly. And since traders have to finance their trade, the longer it lasts, the more they can lose.

“Some people think that when you do an arbitrage trade, you’re locked in and will have a profit,” said Ihor Dusaniwsky, managing director and head of predictive analytics at S3. “But you’re not locked in on financing costs, which are eating into your profits every day, even on weekends.”

AMC-APE Spread On a Wild Ride | Arbitrage trade mirred in borrow costs, legal saga
The analysis, which looked at trades made at the beginning of every month since AMC issued the preferreds last year, found returns ranging from a loss of about 260% to a gain of about 152%. Starting the trade on Feb. 1 could have resulted in losses of more than 190%, while a month later, the trade would have more than doubled investors’ money.

The trade stems from AMC’s status as a meme stock company. It sold common equity to retail investors to raise money for acquisitions. Then it reached the maximum number of shares that its corporate charter allowed it to issue, spurring it in August 2022 to create preferred stock that it called AMC Preferred Equity Units, or APEs.

It sold additional APEs as well, and then sought approval from both classes of investors to convert APEs into common stock. Some common share investors objected to the way that approval process was put together, and sued.

The company negotiated a settlement, which a Delaware judge rejected last week. Then AMC revised its plan, and investors are now hopeful that it will win approval to essentially convert preferreds into common. While originally each APE share was meant to convert into one share of AMC common stock, after the revised plan, the conversion will effectively be one APE share is equal to 0.882353 shares of AMC.

Racing Against TimeS3’s analysis assumed the trader was posting an average daily margin of 15% of the market value of both the long and short positions with their prime broker, recalculated daily to account for swings in asset prices, with variation margin added or subtracted. The profit or losses calculated were based on the assumption that the conversion happened on July 24, and also included borrowing costs.

Read more: AMC-APE Bet Looks Like Easy Money, But It’s Perilous for Traders

The timing for any conversion remains unclear, and the longer the process extends, the harder it will be for many investors to profit from the arbitrage. But some investors can make money even if they unwind now.

“In March, all these trades were profitable,” S3’s Dusaniwsky said. “It’s only later that a lot of these trades became unprofitable.”
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