U.S.-based dealers are expected to sell more call spreads this year as a means of minimizing the potential dilution of convertible securities. Keith Styrcula, chairman of the structured products association in New York, said the strategy took off last year because accounting rule changes and a rise in stock prices combined with a fall in bond values to move many convertible bonds nearer to their triggers, creating a problem of dilution. Dealers including JPMorgan, Goldman Sachs and Morgan Stanley started offering this strategy last year, according to officials.
The call spread strategy allows convertible note issuers to synthetically adjust the notes' conversion price and annualized yield, explained Styrcula. The benefit of doing this is that the structure eliminates potential per-share dilution up to the strike price of the company-issued call option.
Under this strategy, issuers sell warrants with high strikes to dealers at the same time as buying calls with the lower strike of the convertible security, which partially offsets the cost of the trade, Styrcula explained. Some of the spread structures also have a potential tax benefit for convertible issuers, he added.
