How do I use a premium put convertible?

By Justin Bynum AAA
A:

Holders of convertible bonds

face all the pitfalls that traditional bondholders face - liquidity risk, interest rate risk and default risk. But, there is one important difference: convertible bondholders also risk loss of principal due to declines in a company's underlying stock price. Granted, because the price of a convertible bond is closely tied to the price of the underlying equity, the potential for price appreciation is also much greater. However, given bond investors' preference for income first, price appreciation second - and price depreciation never - how can individual convertible bond investors protect themselves?

Enter the premium put convertible. Just like an option, the premium put allows the bondholder to put the bond back to the issuer at a premium before the bond reaches maturity. For this reason, the premium put feature has two distinct advantages over "standard issue" convertible bonds:

  1. Should the value of the underlying stock decline, the bondholder simply can redeem the bond at face value, plus the premium; and
  2. If interest rates rise, the bondholder has the option of redeeming the bonds and lending the proceeds at a higher rate.

Of course, the premium put convertible comes with a price. Almost always, the stated interest rate of the bond is less - sometimes significantly so - than that for a "standard issue" convertible bond.

For more on convertible bonds, read Convertible Bonds: An Introduction.

This question was answered by Justin Bynum.

RELATED FAQS

  1. What does the efficient market hypothesis assume about fair value?

    Found out what the efficient market hypothesis says about the fair value of securities, and learn why technical and fundamental ...
  2. How do I implement a forex strategy when spotting a Triple Bottom Pattern?

    Learn about the triple bottom pattern and how it is used to create effective trade strategy in the forex market, including ...
  3. How are Upside Gap Two Crows patterns interpreted by analysts and traders?

    Learn about the upside gap two crows chart pattern and how analysts and traders interpret this pattern as an indicator of ...
  4. How do I build a profitable trading strategy when spotting an Upside Gap Two Crows ...

    Learn about the upside gap two crows pattern and how this reversal signal is used to create profitable trade strategy, including ...
RELATED TERMS
  1. Indicator

    Indicators are statistics used to measure current conditions ...
  2. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  3. Class 3-6 Bonds

    Several classes of noninvestment grade bonds held by an insurance ...
  4. Forex Spread Betting

    A category of spread betting that involves taking a bet on the ...
  5. Impact investing

  6. Promotional CD rate (Bonus CD rate)

    A limited-time offer of a higher rate of return on a certificate ...

You May Also Like

Related Articles
  1. Charts & Patterns

    Why These Are 2015's Most-Promising ...

  2. Chart Advisor

    Trade Healthcare Providers with this ...

  3. Fundamental Analysis

    Is Apple's Stock Over Valued Or Undervalued?

  4. Trading Strategies

    Trading On The Psychology Of Round Numbers

  5. Chart Advisor

    Commodity Traders Are Using Momentum ...

Trading Center