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Frequent Contributor

UBS Exchange Traded Notes - arbitrage opportunity for the average individual investor

On December 9, UBS announced that it commenced exchange offers for eight ETRACS Series A ETNs for corresponding ETRACS Series B ETNs.  The Series B ETNs are intended to economically identical to the Series A ETNs.  The key difference between the Series A ETNs and the Series B ETNs is that UBS AG and UBS Switzerland AG are each co-obligors on all Series A ETNs, while UBS AG is the sole issuer and obligor on all Series B ETNs. UBS Switzerland AG has no obligations with respect to the Series B ETNs.  UBS AG is conducting the Exchange Offers in order to reduce the intercompany exposures of UBS Switzerland AG to UBS AG in line with regulatory recovery and resolution guidance.

The two series are economically identical, as far as UBS is concerned but are not as far as the market is concerned.  I've been keeping track of the unit prices of each since Dec 9 and, to date, there has usually been a few penny discount/premium spread between each pair, with the Series B unit price usually above the Series A price.  Which presents an arbitrage opportunity for individual investors, like myself, that is not usually available.  The first opportunity to take advantage was Wednesday last week, 1/15.  The next one is next Wednesday, 1/30, followed by the remaining 6 opportunities every two weeks thereafter.

The way it works is that you inform your brokerage that you want to participate in the exchange offer for the shares you hold.  At 4:59 PM EST on the exchange date, your shares are 'frozen', meaning that you can't trade them for the typical 2 day settlement period.  On the settlement date, the replacement Series B ETNs show up in your account.  It's exactly the same as if you sold your shares on the exchange date, to UBS, but without any bid/ask spread, hence no discount/premium involved.  The relatively minor risk you assume is some 3 sigma event happening during that settlement time period, where you are unable to unload the notes for a day or two.

I hold 2 of the 8 notes involved, MORL/MRRL (MREITs) and CEFL/CEFZ (CEFs), both 2X leveraged.  Two of the others are 1X MLP based.  The two BDC based notes involve both the 1X and 2X versions.  The final 2 are linked, 1X, to Bloomber's Commodity indici.

I 'tested' the concept using my CEFL holding last week.  On the exchange date, 1/15, CEFL closed 5 cents a unit lower than CEFZ.  The next day, while both were in limbo, CEFL closed 7 cents lower, while on the settlement date, the spread was back down to 4 cents.  This week, the spread was 7 cents and a whopping 13 cents yesterday.  My brokerage, Firstrade, charged me a flat $25 to do the exchange.  At a 4 cent gain, at least 625 shares were required to break even.  I did considerably more.

It wasn't worth the effort to do this with my other UBS holding, MORL/MRRL, since they tend to trade withing a few pennies of each other.  Besides, I've been in MRRL since going with Firstrade last year, given that MORL went 'floating' on the market (not supported by UBS), given the large average trading volume involved with it.  As a result, it started to trade at a significant premium, while MRRL didn't.

ElLobo, de la casa de la toro caca grande
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Explorer ○○

Re: UBS Exchange Traded Notes - arbitrage opportunity for the average individual investor

Very good but now my brain hurts.

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Frequent Contributor

Re: UBS Exchange Traded Notes - arbitrage opportunity for the average individual investor


@Wheaton wrote:

Very good but now my brain hurts.


Sorry.  That wasn't my intention.  Think of it as 'trading' one fund class for another, where the NAV for the one you started with is lower than the one you got in return!  As opposed to selling one, buying the other, and taking a loss!

ElLobo, de la casa de la toro caca grande
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