37 lines
2.5 KiB
Plaintext
37 lines
2.5 KiB
Plaintext
628 Part V: Index Options and Futu,
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If the action results in a lower strike, it is known as rolling down; if it results in a hi§
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er strike, it is rolling up.
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This rolling action changes the profit potential of the position. If one rolls dov;
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he gets more downside protection, but his upside is even more limited than it prei
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ously was. Still, if he is worried about the stock falling lower, this may be a prop
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action to take. Conversely, if the common is rallying, and the covered writer is mo
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bullish on the stock, he can roll up in order to increase his upside profit potenti~(
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course, by rolling up, he creates more downside risk if the common stock should sue
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denly reverse direction and fall.
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The PERCS holder can achieve the same results as the covered writer. He ca
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effectively roll his redemption price down or up if he so chooses. His reasons fc
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doing so would be substantially the same as the covered writer's. For example, if th
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common were dropping in price, the PERCS holder might become worried that hi
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extra dividend income would not be enough to protect him in the case of furthe
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decline. Therefore, he would want to take in even more premium in exchange fo
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allowing himself to be called away at a lower price.
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Example: XYZ issued PERCS when both were trading at 35. Now, XYZ has fallen t<
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30 with only a year remaining until maturity, and the PERCS holder is nervous abou
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further declines. He could, of course, merely sell his stock; but suppose that ht:
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prefers to keep it and attempt to modify his position to more accurately reflect hb
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attitude about future price movements.
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Assume the following prices exist:
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XYZ Common: 30
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XYZ PERCS: 31
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XYZ January 40 call: 2
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XYZ January 35 call: 4
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Ifhe buys the January 40 call and sells the January 35 call, he will have accomplished
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his purpose. This is the same as selling a call bear spread. As shown in the previous
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example, buying the January 40 call is essentially the same as removing the redemp
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tion feature from the PERCS. Then, selling the January 35 call will reinstate a
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redemption feature at 35. Thus, the PERCS holder has taken in a premium of 2
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points and has lowered the redemption price.
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If XYZ is below 35 when the options expire, he will have an extra $200 profit
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from the option trades. If XYZ rallies and is above 35 at expiration, he will be effec
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tively called away at 37 (the striking price of 35 plus the two points from the rollr,
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instead of at the original demand price of 39. In actual practice, if the January 35 call |