632 Part V: Index Options and Futures 
This is not a static situation. If XYZ changes in price, the delta of the imbedded 
option will change as well, so that the proper amount of stock to sell as a hedge will 
change. The deltas will change with the passage of time as well. A change in volatili­
ty of the common stock can affect the deltas, too. Consequently, one must constant­
ly recalculate the amount of stock needed to hedge the PERCS. 
What one has actually created by selling some common stock against his long 
PERCS holding is another ratio write. Consider the fact that being long 1,000 
PE RCS shares is the equivalent of being long 1,000 common and short 10 imbedded, 
long-term calls. If one sells 700 common, he will be left with an equivalent position 
of long 300 common and short 10 imbedded calls - a ratio write. 
The person who chooses to hedge his PER CS holding with a partial sale of com­
mon stock, as in the example, would do well to visualize the resulting hedged posi­
tion as a neutral ratio write. Doing so will help him to realize that there is both upside 
and downside risk if the underlying common stock should become very volatile (ratio 
writes have risk on both the upside and the downside). If the common remains fair­
ly stable, the value of the imbedded call will decrease and he will profit. However, if 
it is a long-term imbedded call (that is, if there is a long time until maturity of the 
PER CS), the rate of time decay will be quite small; the hedger should realize that 
fact as well. 
In summary, the sale of some common against a long holding of PERCS is a 
viable way to hedge the position. When one hedges in this manner, he must contin­
ue to monitor the position and would be best served by viewing it as a ratio write at 
all times. 
SELLING PERCS SHORT 
Can it make sense to sell PER CS short? The payout of the large dividend seems to 
be a deterrent against such a short sale. However, if one views it as the opposite of a 
long-term, out-of-the-money covered write, it may make some sense. 
A covered write is long stock, short call; it is also equivalent to being long a 
PERCS. The opposite of that is short stock, long call - a synthetic put. Therefore, a 
long put is the equivalent of being short a PERCS. Profit graph Hin Appendix D 
shows the profit potential of being short stock and long a call. There is large down­
side profit potential, but the upside risk is limited by the presence of the long call. 
The amount of premium paid for the long call is a wasting asset. If the stock does not 
decline in price, the long call premium may be lost, causing an overall loss. 
Shorting a PERCS would result in a position with those same qualities. The 
upside risk is limited by the redemption feature of the PERCS. The downside prof­
it potential is large, because the PER CS will trade down in price if the common stoek