Hedge funds, including Calamos Advisors, have turned MicroStrategy into one of Wall Street’s hottest trades, with the company leveraging its role as a bitcoin proxy to secure billions in convertible bond investments, according to a report by Bloomberg.

Amid a 500% rally in MicroStrategy's stock this year, driven by surging bitcoin prices, the firm announced plans to sell $21bn in convertible notes to fund further cryptocurrency purchases. Hedge funds, however, are less interested in MicroStrategy’s stock price or bitcoin holdings. Instead, they are seizing on opportunities for market-neutral arbitrage fuelled by the stock’s extraordinary volatility.

The report cites Eli Pars, co-CIO at Calamos as revealing that his firm has invested over $130m in MicroStrategy’s convertible bonds, which are used in arbitrage strategies that exploit the underlying asset's volatility.

“Convertibles are a way for issuers to monetise the volatility of their stocks, and MicroStrategy is an extreme example,” he said.

The company has issued $7bn in low-interest, long-term convertible bonds this year, with plans to raise $42bn over the next three years. These bonds, exchangeable for equity at certain price thresholds, are attractive to hedge funds deploying arbitrage strategies also used by firms like AQR Capital Management and Man Group.

The arbitrage involves hedging the bonds’ equity exchange feature, treating it as an option tied to the stock’s volatility. MicroStrategy's shares, which average daily moves of 5.2% (compared to 0.6% for the S&P 500), make the strategy particularly lucrative.

MicroStrategy, led by co-founder Michael Saylor, has accumulated a Bitcoin stash worth around $40bn since adopting its cryptocurrency-focused strategy in 2020. The firm has continued to purchase Bitcoin aggressively, buying $13.5bn worth since 31 October.

Saylor has touted the stock’s volatility as an asset, describing it as more volatile than any S&P 500 component. This dynamic, partly driven by Bitcoin’s wild price swings, has made MicroStrategy’s convertible bonds a top pick among hedge funds.

“The trade is attractive because the implied volatility of the converts is way below realised volatility or option-implied volatility,” Pars said.

Despite the appeal, MicroStrategy’s approach hinges precariously on bitcoin’s value, according to sceptics. David Trainer, CEO of market research firm New Constructs, likened the strategy to “a game of musical chairs,” with potentially disastrous consequences if bitcoin’s rally reverses.

“It could be a giant house of cards that will crush many shareholders when it crashes,” Trainer said.