Why Hedge Funds May Pile into APE Shares

Note: This is not financial advice

This morning, new preferred shares of AMC Entertainment Holdings debuted on the New York Stock Exchange.

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Interestingly, the new shares (ticker symbol APE) have the same ownership interest and rights as normal AMC shares. But as I write this, they trade for $5.80, versus $10.52 for AMC shares.

The shares appear ripe for one of Wall Street’s favorite strategies: arbitrage.

If the two share types have the same economic value, they should trade at the same price. Hedge funds often buy an underpriced security while selling short an equivalent higher priced one.

The bet: the two prices will converge.

I expect hedge funds to buy APE shares while shorting AMC common stock. On paper the strategy makes sense, but there’s a little problem…

AMC shares are heavily shorted. 20% of the float has already been sold short.

If hedge funds continue shorting the stock, they become vulnerable to a short squeeze. Huge run-ups in shares of AMC, GameStop Corp. and others have bankrupted hedge funds before, such as Melvin Capital Management.

What’s more, both AMC and APE shares have passionate fanbases that can cause massive volatility. The human factor could cause a seemingly straightforward pairs trade to go very, very wrong.

Hedge funds should heed the lesson of Melvin Capital and avoid shorting volatile meme stocks. But as Benjamin Franklin said:

“Wise men don’t need advice. Fools won’t take it.”

How do you think hedge funds will react to the debut of APE shares? Leave a comment at the bottom and let me know!

More on markets:

AMC’s 9 Million Missing Shares

Is Melvin’s Gabe Plotkin Headed to Prison?

Wall Street Banks Turn on Each Other as Federal Probe Looms

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