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For the first 29 years, a 30-year bond works more or less like any other security, and you can short it just like anything else. However, I'm interested in what happens if you want to short it at the 30-year mark exactly. You can't agree in advance to sell the bond at 30 years plus one week, because at that time the bond will no longer exist.

Let's say my prediction is that the market will trust a 30-year bond completely, right up until the final payment at which time the company will go bankrupt and fail to pay. Is there anything I can do to profit from this?

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  • You know the risk profile changes over the course of the bond? – quid Sep 10 '19 at 16:11
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The company won't be instantly liquidated if it goes into bankruptcy. And if it does, then the bonds will not be repaid and therefore they will exist during the bankruptcy until final liquidation.

For the non-liquidation scenario (i.e. your assumption was wrong and it's paid at par) you can just settle the short at face value, since the bond has proven to be worth its face value.

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Going out on a limb here, but if you posit that the market trusts the 30-year bond completely up to and including the penultimate payment, why pay borrowing costs for the short position all that time?

Just let it be, then short it at the penultimate payment. Or if you have the capital and are happy with the income stream and the liquidity of the bond up to the penultimate payment, then buy it now and sell it at the penultimate payment.

If you're concerned about not being able to buy the bond back, consider the following (it refers to stocks, but it sounds like it would apply to bonds as well):

Quite simply, if you have an open short position in a company that gets delisted and declares bankruptcy, then you don't have to pay back anyone because the shares are worthless. - investopedia

Disclaimer: this is not to be construed as financial advice.

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  • Buying and then selling the bond won't work. When you buy the bond, you are paying full value for the penultimate payment that you think is worthless. Nothing you can do after that makes up for that loss. – David Schwartz Oct 10 '19 at 17:37
  • @DavidSchwartz Buy/sell refers to extracting the coupon payments in the usual way over the first 29 years, not to get capital appreciation over the last year. The alternative strategy suggested for the last year (if they haven’t already bought the bond) is to short-sell the bond. – Lawrence Oct 11 '19 at 1:53
  • Since it requires him to overpay for the bond to get those payments, it's a losing strategy if he believes that the last payment will be defaulted on. Nothing that happens later in that strategy can make up for the initial overpayment -- it gets him absolutely nothing but something he overpaid for. – David Schwartz Oct 11 '19 at 15:58
  • @DavidSchwartz The OP has posits a market that trusts the bond completely. So the price should be near par just before the sale. Buy at par and sell near par - what overpayment are you talking about? – Lawrence Oct 12 '19 at 8:58
  • If he believes the last payment won't be made, then when he buys the bond, he is paying full price for the right to a payment he won't get. He'd have to be an idiot to do that. There's nothing he can do later to compensate him for that loss. Selling the bond before it defaults leaves him with no benefit because it, at best, cancels out some of the loss he took when he bought. – David Schwartz Oct 13 '19 at 0:02
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Short the stock while holding the bond. If the company is in trouble then the gain on the short stock will be larger than the loss on the long bond. Also, if the company goes bankrupt then the holders of the senior debt mostly become the new stockholders with the previous stockholders usually wiped-out.

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