38 lines
2.8 KiB
Plaintext
38 lines
2.8 KiB
Plaintext
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 |