Chinese Hedge

Before they got the idea of building a wall out of stones and bricks, China's Ming dynasty tried to keep barbarians out using really tall plant formations. This "Chinese Hedge" was a colossal failure (attempts to brand it the "Great Hedge of China" were roundly mocked).

Eh, okay...this is actually the name of a trading hedge. The more culturally sensitive name for this position is a "reverse hedge." It's a way to arbitrage market fluctuations in the prices of convertible securities.

Take a convertible bond. This type of security acts like a standard corporate bond (with an interest rate and maturity date, etc.) and has the added benefit of an option to convert it into shares of stock under certain conditions. Because of this additional benefit, these bonds trade at a premium compared to vanilla bonds from the same company with similar rates and maturities.

In a Chinese hedge, you are attempting to profit on a potential overvaluation of this convertibility. Basically, you think the market has priced in too much of a premium for the convertible part of the bond. So you short the convertible security (bet that its price will go down), while going long the underlying stock (basically, buying shares). Then, if the stock goes up, messing up your short on the convertible instrument, the investor can profit on the rise in the stock price.