36 lines
2.3 KiB
Plaintext
36 lines
2.3 KiB
Plaintext
88 Part II: Call Option Strategies
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return concept - is described that has great appeal to large stockholders, both indi
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viduals and institutions.
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COVERED WRITING AGAINST A CONVERTIBLE SECURITY
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It may be more advantageous to buy a security that is convertible into common stock
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than to buy the stock itself, for covered call writing purposes. Convertible bonds and
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convertible preferred stocks are securities commonly used for this purpose. One
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advantage of using the convertible security is that it often has a higher yield than does
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the common stock itself.
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Before describing the covered write, it may be beneficial to review the basics of
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convertible securities. Suppose XYZ common stock has an XYZ convertible Preferred
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A stock that is convertible into 1.5 shares of common. The number of shares of com
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mon that the convertible security converts into is an important piece of information
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that the writer must know. It can be found in a Standard & Poor's Stock Guide (or
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Bond Guide, in the case of convertible bonds).
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The writer also needs to determine how many shares of the convertible securi
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ty must be owned in order to equal 100 shares of the common stock. This is quickly
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determined by dividing 100 by the conversion ratio - 1.5 in our XYZ example. Since
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100 divided by 1.5 equals 66.666, one must own 67 shares of XYZ cv Pfd A to cover
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the sale of one XYZ option for 100 shares of common. Note that neither the market
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prices of XYZ common nor the convertible security are necessary for this computa
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tion.
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When using a convertible bond, the conversion information is usually stated in
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a form such as, "converts into 50 shares at a price of 20." The price is irrelevant. What
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is important is the number of shares that the bond converts into - 50 in this case.
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Thus, if one were using these bonds for covered writing of one call, he would need
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two (2,000) bonds to own the equivalent of 100 shares of stock.
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Once one knows how much of the convertible security must be purchased, he
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can use the actual prices of the securities, and their yields, to determine whether a
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covered write against the common or the convertible is more attractive.
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Example: The following information is known:
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XYZ common, 50;
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XYZ CV Pfd A, 80;
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XYZ July 50 call, 5;
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XYZ dividend, 1.00 per share annually; and
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XYZ cv Pfd A dividend, 5.00 per share annually. |