38 lines
2.6 KiB
Plaintext
38 lines
2.6 KiB
Plaintext
0.,t,r 32: Structured Products 619
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t'Ussed in the remainder of this chapter, resembles the covered write of a call
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option. These often have names involving the term preferreds. Some are called
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Trust Preferreds; another popular term for them is Preferred Equity Redemption
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Cumulative Stock (PERCS). We will use the term PERCS in the following exam
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ples, but the reader should understand that it is being used in a generic sense - that
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any of the similar types of products could be substituted wherever the term PERCS
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is used.
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A PERCS is a structured product, issued with a maturity date and tied to an
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individual stock. At the time of issuance, the PERCS and the common stock are usu
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ally about the same price. The PERCS pays a higher dividend than the common
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stock, which may pay no dividend at all. If the underlying common should decline in
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price, the PERCS should decline by a lesser amount because the higher dividend
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payout will provide a yield floor, as any preferred stock does.
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There is a limited life span with PERCS that is spelled out in the prospectus at
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the time it is issued. Typically, that life span is about three years. At the end of that
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time, the PERCS becomes ordinary common stock.
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A PERC S may be called at any time by the issuing corporation if the company's
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common stock exceeds a predetermined call price. In other words, this PERCS stock
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is callable. The call price is normally higher than the price at which the common is
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trading when the PERCS is issued.
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What one has then, if he owns a PERCS, is a position that will eventually
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become common stock unless it is called away. In order to compensate him for the
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fact that it might he called away, the owner receives a higher dividend. What if one
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substitutes the word "premium" for "higher dividend"? Then the last statement
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reads: In order to compensate him for the fact that it might be called away, the owner
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receives a premium. This is exactly the definition of a covered call option write.
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Moreover, it is an out-of-the-money covered write of a long-term call option, since
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the call price of the PERCS is akin to a striking price and is higher than the initial
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stock price.
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Example: XYZ is selling at $35 per share. XYZ common stock pays $1 a year in div
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idends. The company decides to issue a PERCS.
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The PERCS will have a three~ life and will be callable at $39. Moreover, the
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PERCS will pay an annual dividend of $2.50.
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The PERCS annual dividend rate is 7% as compared to 2.8% for the common
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stock.
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If XYZ were to rise to 39 in exactly three years, the PERCS would be called.
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The total return that the PERCS holder would have made over that time would be: |