36 lines
2.3 KiB
Plaintext
36 lines
2.3 KiB
Plaintext
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. |