This story begins with the brainchild of some investment banker. It’s known as a capped call transaction. When entered into concurrently with a convertible debt offering, the intent of a capped call is to help the issuer minimize share dilution resulting from the eventual conversion of debt into equity.
Like any other exotic derivative, the idea sounds good, but things don't always play out as planned.
Over the past year or two, firms ranging from Advanced Micro Devices
In all such transactions, the bankers selling the convertibles may help the note buyers to protect their investment via a short sale or some other derivative transaction involving the common stock. The bank may hedge its own exposure to the capped call agreement, too. This is confusing stuff, but bear with me.
This spring, when JA Solar
Now that Lehman has declared bankruptcy, though, it's unclear whether JA or Evergreen can get their formerly phantom-like lent shares back. Ditto for SunPower
These firms are being punished more or less in proportion to the dilution that would result in the worst-case scenario. While these agreements never should have been entered into in the first place, it's important to recognize that the firms' business operations aren't directly affected. If you're tempted to buy on this sell-off, I would assume the full share-count hit and work from there.