35 lines
2.3 KiB
Plaintext
35 lines
2.3 KiB
Plaintext
O.,,ter 32: Structured Products 623
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TI1is is the typical picture of the total return from a covered write - potential losses on
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the downside with profit potential limited above the striking price of the written call.
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Now look at the profitability of buying the PER CS at 35 and holding it for three
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(Assume that it is not called prior to maturity.) The PER CS holder will earn a
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total of $750 in dividends over that time period.
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XYZ Price Profit/Loss on Total Profit/Loss
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in 3 Years PERCS Incl. Dividend
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25 -$1,000 -$250
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30 -500 +250
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35 0 +750
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>=39 +400 + 1, 150
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This is exactly the same profitability as the covered call write. Therefore, it can be
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concluded with certainty that a PERCS is equivalent to a covered call write. Note
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that the PER CS potential early redemption feature does not change the truth of this
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statement. The early redemption possibility merely allows the PERCS holder to
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receive the same total dollars at an earlier point in time if the PERCS is demanded
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prior to maturity. The covered call writer could theoretically be facing a similar situ
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ation if the written call option were assigned before expiration: He would make the
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same total profit, but he would realize it in a shorter period of time.
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The PERCS is like a covered write of a call option with striking price equal to
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the redemption price of the PERCS, except that the holder does not receive a call
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option premium, but rather receives additional dividends. In essence, the PERCS
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has a call option imbedded within it. The value of the imbedded call is really the
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value of the additional dividends to be paid between the current date and maturity.
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The buyer of a PERCS is, in effect, selling a call option and buying common
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stock. He should have some idea of whether or not he is selling the option at a rea
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sonably fair price. The next section of this chapter addresses the problem of valuing
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the call option that is imbedded in the PERCS.
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PRICE BEHAVIOR
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The way that a PERCS price is often discussed is in relationship to the common
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stock. One may hear that the PERCS is trading at the same price as the common or
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at a premium or discount to the common. As an option strategist who understands
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covered call writing, it should be a simple matter to picture how the PERCS price
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will relate to the common price. |