The convertible market will likely improve this year, giving issuers the option to raise capital at better terms than last year and investors more opportunities to make money, according to strategists and capital markets executives.

Equity volatility, a key factor driving liquidity because it gives arbitrage investors opportunities to trade convertibles, is expected to rise, according to a report by Lehman Brothers on Thursday. Uncertainties regarding the housing market, energy prices, economic growth, and a lack of market consensus on rates if the Federal Reserve slows its rate hikes, would all add to a pickup in volatility, said Venu Krishna, lead author, adding that as in any market, there are always risks of a return to poor fundamentals. He also pointed to the sizable difference between the current implied volatility in the S&P 500 Index and the 9-month implied volatility as evidence for a pickup.

"I expect issuance volumes to pick up this year as interest rates stabilize and volatility conditions improve," said Brooks Harris, head of convertibles at Deutsche Bank. He added issuance will also be driven by refinancings since a number of companies issued convertibles in the early 2000s. M&A and the need to fund stock repurchases may also boost new offerings.

A rise in volatility would also lead issuers to increase use of the call-spread overlay structure, whereby a company sells a regular convertible to investors and then enters into a derivative contract with its underwriter. Higher volatility boosts the value of the options and the investment bank can then pass on this rise in value to the issuer. The end result is an effective lower coupon and a higher conversion premium for the issuer, but not for the investor.

"I think it's going to be attractive for high volatility companies. As volatility increases, the terms will improve and make this more applicable to more clients," said Steve Winnert, head of equity-linked origination at Credit Suisse First Boston, which made some key contributions to the popularization of the call-spread overlays starting in 2002.

And the asset class is expected to win back some of the business it lost to high yield last year. "The Fed's raised rates several times and the convertible market is now a more compelling option on a relative basis," noted Fred Fiddle, head of convertibles at Merrill Lynch.