How to Trade the Price Discrepancy
The least complicated way to trade this price discrepancy involves shorting Class A shares and buying Class B shares at the widest point in the discrepancy’s historical range. In practice, this requires traders to open a position at a spread of $.10 per share and close it at a spread of about $.03 per share. Although this trade seems like a “sure thing” on paper, its efficacy could be hampered by the relative paucity of Class A shares available for shorting. There are usually 25,000 to 500,000 “shortable” shares at any given brokerage.
Arbitrageurs may find it even more profitable to convert Class A ADRs into Class B shares. Once the Class B shares have come through, a conversion back to regular Class A shares would produce an instantaneous arbitrage opportunity that provides an added bonus: the accrued Class B dividends.
Since these dividends now come in the form of Class A shares, they are actually more valuable than the corresponding cash payments would be. At the Class B ADR’s current price, each Class A “dividend” is worth more than the old cash dividends. Since each Class B ADR is equivalent to four Class B shares, it accrues dividends at four times the rate of a regular share. This can quickly produce returns on the order of 15 to 25 percent.
Longer-term investors may simply wish to hold PRISA’s Class B ADRs until their May 2014 expiration date. Upon expiration, it appears likely that each Class B ADR will be convertible to 1.33 Class A ADRs plus the value of any accrued dividends. To maximize its return, this trade also requires long-term investors to hold a corresponding short position in Class A ADRs until the Class B expiration date. If this is done correctly, it could produce a return north of 80 percent. Any investor considering the trade should look at all the details.
It is important to note that this trend could “break” at any time. Investors who stick to the first trade could find themselves scrambling for the exits during a sudden Class A buy-in at a once-firm resistance point. Alternatively, the spread could widen further than it has in the past and expose investors to margin calls. As with any trade that involves a significant short position, interested investors should ensure that their trading accounts contain enough cash to absorb a surprise margin call.
The article This Share Class Arbitrage Is Still Alive originally appeared on Fool.com and is written by Mike Thiessen.
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