Traders' Expectations Of AMC's Stock Conversion Aren't Accurate

Profit from the $5 difference in the proposed conversion of preferred stock into common shares by AMC Entertainment Holdings Inc. Yet Wall Street experts are finding that the wager is everything but simple to execute.

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What's the problem?

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CEO of Accelerate Financial Technologies Julian Klymochko said, "It's simple, but not easy. Although the conversion of the dual share classes is very straightforward, it can be challenging to do it profitably.

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Due of the difficulty in finding shares of the meme-stock posterchild to borrow and short, the cost of hedging the move is skyrocketing. A recent court case against the movie theater chain's share plan has made matters worse, raising doubts about whether the restructure would really take place.

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That was intended to be a simple wager. Investors would approve the conversion of AMC's preferred units (ticker APE) into common shares, and the price difference between them would disappear as arbs absorbed that spread. But things aren't turning out that way because lawsuits could postpone the restructuring and because retail traders are boosting the price of the common shares.

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The margin is currently $5 and hit its biggest level since December earlier this week, with AMC outperforming APE, with the election less than two weeks away. Furthermore, there is probably no end in sight.

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Reduce Risk

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AMC has permission to proceed with the shareholder vote, but it won't be able to make any modifications until the judge has finished considering an injunction request made by the pension fund and other investors who are spearheading the action. April 27 is the date of the hearing.

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That implies that traders using stocks and options would have to keep their bets for a longer period of time, which would reduce possible earnings.

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"The litigation delays the process and raises uncertainty," Klymochko continued. "The short squeeze risk is present until the reorganization is completed."

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The strategy, which a market strategist reportedly referred to as an arbitrage "home run," entails shorting AMC stock and purchasing APE in an effort to make up the difference when the conversion is granted.

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The cost to borrow AMC shares is "punishingly high," according to JonesTrading's Cabot Henderson, making the simple technique risky. Given the meme stock's propensity to skyrocket in a short squeeze, it is difficult to even find shares to sell short, further complicating the deal.

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As "APEs," or retail traders, bid up shares and promote their wagers on social media sites like Reddit's WallStreetBets and Stocktwits, where they urge others to help pressure investors betting against the stock, retail traders have been enthralled by AMC.

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Burning traders have started imitating the arbitrage strategy introduced by renowned short-seller Jim Chanos. Kynikos Associates founder Chanos told Trade Algo that he was "depending on them to close" and thought "ultimately they'll all be the same class," adding that he thought the share classes "should be the same price, or nearly the same price."

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Earnings

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Following the release of the movie theater chain's fourth-quarter statistics on Wednesday, both AMC and APE saw declines as investors and analysts turned their attention to the transaction vote. According to analysts, including Eric Wold of B Riley, investors will support the restructure, rendering the litigation pointless.

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If that transpires, Wold, who rates the company as neutral, said, "we view it would be tough for a judge to declare the plans are not in the best interest of shareholders if they vote that way.

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Risks abound in the meantime. According to data from S3 Partners, roughly three times as many AMC shares are currently sold short as there are available for trade. Finally, the erratic behavior of meme stocks, whose prices are  often detached from reality.  

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Investing in a meme-stock entails acknowledging that you're doing business in "uncharted territory," according to Churchill Capital's Nicholas Pappas.

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Artificial Borrow

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As an alternative, some traders have been borrowing shares of AMC through the use of options structures, according to Chris Colpitts, director of event-driven strategies at Cowen.

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The issue of borrowing stability is addressed by a so-called synthetic borrow, or reverse conversion, however the safety net only lasts until options expire. As a result of the anticipated delay, traders must now decide whether to unwind their holdings or roll the options package to a longer-dated expiry at an additional cost.

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AMC's plan to generate money and keep the lights on includes the one-for-one exchange of preferred stock for common shares. Also, a 10-to-1 reverse stock split is being proposed.

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Trading still offers the possibility of a fantastic potential return in a short amount of time, even with that large exchange spread. Yet, according to Klymochko, it's probably only for those who could handle the erratic and extremely explosive turns.

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It's pretty dangerous, he said, and there are many of possible ways to lose money.