Chapter 2: Covered CaH Writing 89 
Note that, in either case, the same call - the July 50 -would be written. The use of 
the convertible as the underlying security does not alter the choice of which option to 
use. To make the comparison of returns easier, commissions are ignored in the cal­
culations given in Table 2-25. In reality, the commissions for the stock purchase, 
either common or preferred, would be very similar. Thus, from a numerical point of 
view, it appears to be more advantageous to write against the convertible than against 
the common. 
TABLE 2-25. 
Comparison of common and convertible writes. 
Write against Common Write against Convertible 
Buy underlying security $5,000(100 XYZ) $5,360 (67 XYZ CV Pfd A) 
Sell one July 50 call 500 - 500 
Net cash investment $4,500 $4,860 
Premium collected $ 500 $ 500 
Dividends until July 50 250 
Maximum profit potential $ 550 $ 750 
Return (profit divided by 
investment) 12.2% 15.4% 
When writing against a convertible security, additional considerations should be 
looked at. The first is the premium of the convertible security. In the example, with 
XYZ selling at 50, the XYZ cv Pfd A has a true value of 1.5 times 50, or $75 per share. 
However, it is selling at 80, which represents a premium of 5 points above its com­
puted value of 75. Normally, one would not want to buy a convertible security if the 
premium is too large. In this example, the premium appears quite reasonable. Any 
convertible premium greater than 15% above computed value might be considered 
to be too large. 
Another consideration when writing against convertible securities is the han­
dling of assignment. If the writer is assigned, he may either (1) convert his preferred 
stock into common and deliver that, or (2) sell the preferred in the market and use 
the proceeds to buy 100 shares of common stock in the market for delivery against 
the assignment notice. The second choice is usually preferable if the convertible 
security has any premium at all, since converting the preferred into common causes 
the loss of any premium in the convertible, as well as the loss of accrued interest in 
the case of a convertible bond.