Current Price – $20.05
Expected Price – $19.20
Upside – 4%
Expiration timeframe – 1-2 weeks
This is a fairly simple and straightforward arbitrage idea. QQQX is a closed and fund that is mimicking Nasdaq 100 index and trying to juice up the returns by selling covered calls. Historically this fund has always traded at c. 5% discount to NAV – discount to NAV prevails mainly due to funds admin fees, which are levied on shareholders returns. You can see NAV vs share price comparison here and further details on the fund and its holdings in here. For some reason over the last 5 days this discount has suddenly narrowed to 0.82%.
I have not found any news that would warrant such a change. So my trade here is to short QQQX with expectation that discount will return to historical 5% in the upcoming week or two. To eliminate exposure to the underlying assets (Apple, Google, Microsoft, Facebook and etc), I am hedging with an equal dollar amount long position in PowerShares QQQ, which is an ETF tracking the same Nasdaq 100 index and has almost identical portfolio allocations as QQQX. With this hedge my main remaining exposure is to the NAV discount of QQQX. There is also somewhat more technical coverage of this trade on SA.
– QQQ is not a perfect hedge to QQQX – there are slight differences in portfolio allocations and on top of that QQQX is selling covered calls. So QQQX returns would theoretically be higher than the ones of QQQ in falling markets. So if the markets start to fall my trade might not work out. But still that does not explain why the discount to NAV has narrowed so significantly. – Current borrow fees for QQQX stand at 6% annually (in IB) and if the discount does not revert to historical 5% in short term, these borrow fees will weight heavily on expected arbitrage returns. I do not intend to hold this position for more than 1-2 weeks, so current borrow fees are not significant. If borrow fees start to rise, the position might need to be liquidated even earlier.
– There is a small probability that discount will narrow even further, but as it is already at only 0.82% there is not much space for further narrowing, and I do not expect QQQX to start trading at a premium to NAV (almost unheard of for CEFs, especially for index tracking ones). Even if management announces liquidation of the fund (have not heard anything in this direction), the current tiny discount would probably still prevail until we get closer to full liquidation date.
– I have not managed to find any explanation for the recent narrowing of the discount, so I might have missed some crucial detail.