38 lines
2.8 KiB
Plaintext
38 lines
2.8 KiB
Plaintext
Chapter 32: Structured Products 633
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does. The problem for the short seller of the PER CS is that he has to pay a lot for
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the imbedded call that affords him the protection from upside risk. The actual price
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that he has to pay is the dividends that he, as a short seller, must pay out. But this can
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also be thought of as having purchased a long-term call out-of-the-money as protec
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tion for a short sale of common stock. The long-term call is bound to be expensive,
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since it has a great deal of time premium remaining; moreover, the fact that it is out
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of-the-money means that one is also assuming the price risk from the current com
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mon price up to the strike of the call. Hence, this out-of-the-money amount plus the
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time value premium of the imbedded call can add up to a substantial amount.
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This discussion mainly pertains to shorting a PERCS near its issuance price and
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date. However, one is free to short PERCS at any time if they can be borrowed. They
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may be a more attractive short when they have less time remaining until the maturi
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ty date, or when the underlying common is closer to the redemption price.
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Overall, one would not normally expect the short sale of a PERCS to be vastly
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superior to a synthetic put constructed with listed options. Arbitrageurs would be
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expected to eliminate such a price discrepancy if one exists. However, if such a situ
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ation does present itself, the short seller of the PERCS should realize he has a posi
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tion that is the equivalent of owning a put, and plan his strategy accordingly.
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DETERMINING THE ISSUE PRICE
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An investor might wonder how it is always possible for the PERCS and the common
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to be at the same price at the issue date. In fact, the issuing company has two vari
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ables to work with to ensure that the common price and the PERCS issue price are
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the same. One variable is the amount of the additional dividend that the PERCS will
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pay. The other is the redemption price of the PER CS. By altering these two items,
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the value of the covered write (i.e., the PERCS) can be made to be the same as the
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common on the issue date.
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Figure 32-7 shows the values that are significant in determining the issue price
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of the PE RCS. The line marked Final Value is the shape of the profit graph of a cov
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ered write at expiration. This is the PERCS's final value at its maturity. The curved
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line is the value of the covered write at the current time, well before expiration. Of
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course, these two are linked together.
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The line marked Common Stock is merely the profit or loss of owning stock.
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The curved line (present PERCS value) crosses the Common Stock line at the issue
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price.
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At the time of issuance, the difference between the current stock price and the
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eventual maturity value of the PER CS is the present value of all the additional divi
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dends to be paid. That amount is marked a1/11e vertical line on the graph. Therefore, |