An asset swapped convertible option transaction, or ASCOT, is a financial instrument which allows investors to separate the fixed-income and equity components of a convertible bond. ASCOTs are used mainly to remove credit risk and provide opportunities for strategies such as convertible arbitrage.

An ASCOT is composed of two components: a convertible bond and an American call option on the stock of the issuer of the convertible bond. The strike price of the call option must be set at a level that accounts for the costs associated with unwinding the position at maturity. To structure an ASCOT, an investor takes a long position in the convertible bond and sells a call option on the stock of the issuer of the convertible. The investor must deposit a collateral amount with the counterparty, which is typically a bank, to cover the call option.

The advantage of using ASCOTs is that the investor does not have to take on credit risk, as the price of the call option would increase if the credit worthiness of the issuer deteriorates. The downside is that the investor may earn less from the convertible bond, as the strike price of the call option accounts for the potential gains of the underlying stock. In addition, the investor may need to pay a higher premium for the call option than they would have to pay if they purchased the stock outright.

An ASCOT can also be used in a strategy known as convertible arbitrage, in which the investor buys a convertible bond and simultaneously shorts the stock of the issuer. The investor will then use the proceeds from the sale to purchase the call option, thereby reducing their risk or making a profit from the price difference between the convertible bond and the call option.

Overall, ASCOTs are a good way for investors to separate the fixed-income and equity components of a convertible bond and to reduce the risk associated with the creditworthiness of the issuer. They also provide opportunities for investors to pursue strategies such as convertible arbitrage.