Cl,apter 32: Structured Produds 631 
To remain neutral, one would have to keep computing the deltas of the options, 
both listed and imbedded, as time passes, because stock movements or the passage 
of time could change the deltas and therefore affect the neutrality of the position. 
HEDGING PERCS WITH COMMON STOCK 
Some traders may want to use the common stock to hedge the purchase of PERCS. 
These would normally be market-makers or block traders who acquire the PERCS in 
order to provide liquid markets or because they think they are slightly mispriced. The 
simplest way for these traders to hedge their long PERCS would be with common 
stock. 
This strategy might also apply to an individual who holds PERCS, if he wants to 
hedge them from a potential price decline but does not actually want to sell them (for 
tax reasons, perhaps). 
In either case, it is not correct to sell 100 shares of common against each 100 
shares of PERCS owned. That is not a true hedge. In fact, what one accomplishes by 
doing that is to create a naked call option. A PERCS is a covered write; if one sells 
100 shares of common stock from a covered write, he is left with a naked call. This 
could cause large losses if the common rallies. 
Rather, the proper way to hedge the PERCS with common stock is to calculate 
the equivalent stock position of the PERC S and hedge with the calculated amount of 
common stock. The example showed how to calculate the ESP of the PERCS: One 
must calculate the delta of the imbedded call option, which may be a long-term one. 
Then the delta of the PERCS can be computed, and the equivalent stock position can 
be determined. 
Example: V sing the same prices from the previous example, one can see how much 
stock he would have to sell in order to properly hedge his PERCS holding of 1,000 
shares. 
Assume XYZ is trading at 33, and the PE RCS has two years until maturity. If the 
PERCS is redeemable at 39 at maturity, one can determine that the delta of the 
imbedded option is 0.30 (see previous example). Then: 
Delta of PE RCS = 1 - Delta of imbedded call 
= 1- 0.30 
= 0.70 
Hence, the equivalent stock position of 1,000 PERCS is 700 shares (1,000 x 
0.10). 1 Consequently, one would sell short 700 shares of XYZ common in order to 
hedge this long holding of 1,000 PERCS.