Here we are in the middle of October, which means the heart of baseball’s post-season. As you know, I’m always looking for connections between seemingly unrelated topics, using a core of financial derivatives including convertibles. (I’ve made the case that convertibles represent the primary asset of corporate finance, with equity and debt as derivatives, but that’s another story). I started 25 years ago with my comparison of option sensitivities (Greeks, fitting for me given my interest in classical languages) and stages of a basketball game. Today I’ll talk baseball.
What do the four remaining teams have in common? They share cores of talented young—extremely young in some cases—everyday players, with a veteran or two sprinkled in for stability. Then they stir in experienced pitchers. The pitcher, of course, is by far the most important player on the field. Winning teams, then, possess a mix of explosive (favorably volatile) upside with defense (downside protection) at the center.
So do the best convertibles. The essential structure is like a top starting pitcher. Even when the offense struggles, like a stock that can’t get out of its own way, the pitcher will keep the game close. Getting paid to wait, you might say. In the games where the offense overpowers the other team, the pitching isn’t as important—you just need it to be decent. Similarly, when a convertible skyrockets on the back of a stock breakout, it’s important to maintain that lead. You do it by selling or hedging, just as a team with a big lead plays more cautiously, conceding a run here or there to avoid a big inning by the opposition.
They say that in a short series good pitching beats good hitting, and that’s holding true in most games this fall. The hometown Yankees, after all, have lost two games by identical 2-1 scores. That’s the way baseball is supposed to be played. Pitching keeps you close, just as a convertible’s pull to par over time minimizes the damage of an underperforming stock. Disasters are still disasters: a pitcher knocked out in the first inning, a company whose accounting proves, shall we say, faulty. Avoid them and you stay in the game, and if you stay in the game long enough, you have an awfully good chance of winning. And even when you lose, as the Yankees did twice in Houston, you’ve won in a bigger sense. You’ve played honorably and well, and you’ve given your fans—your investors—plenty of reasons to keep coming back.
One last thing—I mentioned classical languages and odd connections above. I hope you’ll get my new book, Latin, Greek and Money: What You Need to Know. While you’re at it, get one for someone you know who’s beginning a career. I promise it will help them shine in job interviews.
(This is the cover letter for the subscription-based weekly Hillside's Hybrid Vigor newsletter. For a complete copy, please contact John Anderson at + 1 (646) 712-9289 x 107).