35 lines
2.1 KiB
Plaintext
35 lines
2.1 KiB
Plaintext
Chapter 2: Covered CaH Writing 89
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Note that, in either case, the same call - the July 50 -would be written. The use of
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the convertible as the underlying security does not alter the choice of which option to
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use. To make the comparison of returns easier, commissions are ignored in the cal
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culations given in Table 2-25. In reality, the commissions for the stock purchase,
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either common or preferred, would be very similar. Thus, from a numerical point of
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view, it appears to be more advantageous to write against the convertible than against
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the common.
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TABLE 2-25.
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Comparison of common and convertible writes.
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Write against Common Write against Convertible
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Buy underlying security $5,000(100 XYZ) $5,360 (67 XYZ CV Pfd A)
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Sell one July 50 call 500 - 500
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Net cash investment $4,500 $4,860
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Premium collected $ 500 $ 500
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Dividends until July 50 250
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Maximum profit potential $ 550 $ 750
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Return (profit divided by
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investment) 12.2% 15.4%
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When writing against a convertible security, additional considerations should be
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looked at. The first is the premium of the convertible security. In the example, with
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XYZ selling at 50, the XYZ cv Pfd A has a true value of 1.5 times 50, or $75 per share.
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However, it is selling at 80, which represents a premium of 5 points above its com
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puted value of 75. Normally, one would not want to buy a convertible security if the
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premium is too large. In this example, the premium appears quite reasonable. Any
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convertible premium greater than 15% above computed value might be considered
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to be too large.
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Another consideration when writing against convertible securities is the han
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dling of assignment. If the writer is assigned, he may either (1) convert his preferred
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stock into common and deliver that, or (2) sell the preferred in the market and use
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the proceeds to buy 100 shares of common stock in the market for delivery against
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the assignment notice. The second choice is usually preferable if the convertible
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security has any premium at all, since converting the preferred into common causes
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the loss of any premium in the convertible, as well as the loss of accrued interest in
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the case of a convertible bond. |