38 lines
2.6 KiB
Plaintext
38 lines
2.6 KiB
Plaintext
626 Part V: Index Options and Futures
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Once one realizes that a PERCS is equivalent to a covered write, he can easily
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extend that equivalence to other positions as well. For example, it is known that a
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covered call write is equivalent to the sale of a naked put. Thus, owning a PERCS is
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equivalent to the sale of a naked put. Obviously, the easiest way to hedge a naked put
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is to buy another put, preferably out-of-the-money, as protection.
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Do not be deluded into thinking that selling a listed call against the PERCS is
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a safe way of hedging. Such a call option sale does add a modicum of downside pro
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tection, but it exposes the upside to large losses and therefore introduces a potential
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risk into the position. It is really a ratio write. The subject is covered later in this
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chapter.
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REMOVING THE REDEMPTION FEATURE
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At issuance, the imbedded call is a three-year call, so it is not possible to exactly
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duplicate the PERCS strategy in the listed market. However, as the PERCS nears
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maturity, there will be listed calls that closely approximate the call that is imbedded
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in the PERCS. Consequently, one may be able to use the listed call or the underly
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ing stock to his advantage.
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If one were to buy a listed call with features similar to the imbedded call in a
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PERCS that he owned, he would essentially be creating long common stock. Not that
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one would necessarily need to go to all that trouble to create long common stock, but
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it might provide opportunities for arbitrageurs.
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In addition, it might appeal to the PERCS holder if the common stock has
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declined and the imbedded call is now inexpensive. If one covers the equivalent of
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the imbedded call in the listed market, he would be able to more fully participate in
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upside participation if the common were to rally later. This is not always a profitable
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strategy, however. It may be better to just sell out the PERCS and buy the common
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if one expects a large rally.
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Example: XYZ issued a PERCS some time ago. It has a redemption price of 39; the
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common pays a dividend of $1 per year, while the PER CS pays $2.50 per year.
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XYZ has fallen to a price of 30 and the PERCS holder thinks a rally may be
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imminent. He knows that the imbedded call in the PERCS must be relatively inex
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pensive, since it is 9 points out-of-the-money (the PERCS is redeemable at 39, while
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the common is currently 30). Ifhe could buy back this call, he could participate more
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fully in the upward potential of the stock.
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Suppose that there is a one-year LEAPS call on XYZ with a striking price of 40.
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If one were to buy that call, he would essentially be removing the redemption fea-
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ture from his PERCS.
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Assume the following prices exist: |