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Matt Levine

SEC Investigates Bank of America for Doing Nothing

Let us construct and then deconstruct a leveraged conversion in our minds' eyes.

Here's a Wall Street Journal article about a Securities and Exchange Commission investigation into "whether Bank of America Corp. broke rules designed to safeguard client accounts" by doing "an array of complex trades and loans" with clients. Generically, I delight in this sort of thing, but specifically, I don't know what those complex trades were or how they worked. But here we are on the Internet, so let's not let that slow us down. Instead, let's just reason the trades out from first principles.

We do have one important clue, which is that "one variety of the strategy, launched around 2009, was called 'leveraged conversion.'" Let's just start with the name: "leveraged conversion." Sheldon Natenberg, who wrote a good book on options, defines a conversion as a trade "where the underlying contract is offset by the sale of a synthetic position": buy stock, sell a call, buy a put with the same strike price. Schematically: