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 are the best indicators for evaluating technology stocks?

    Technology stocks are often some of the most discussed stocks on the news. How can investors spot the company that will roll ...
  2. What technical indicators can I use to find undervalued stock?

    Investors seeking new ideas may want to look to technical analysis to see whether the market has undervalued a particular ...
  3. What's the difference between binary options and day trading?

    Binary options and day trading are both ways to make (or lose) money in the financial markets, but they are different animals. ...
  4. I want to invest my emergency fund to earn interest. What is a relatively safe and ...

    When considering where to put your emergency money, a key consideration is making sure you'll be able to access the money ...
RELATED TERMS
  1. Class 3-6 Bonds

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

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

  4. Promotional CD rate (Bonus CD rate)

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

    An entity that purchases Treasury securities at auction for a ...
  6. Indirect Bidder

    An entity that purchases Treasury securities at auction through ...
comments powered by Disqus
Related Articles
  1. The Six Things Investors Should Do Now
    Fundamental Analysis

    The Six Things Investors Should Do Now

  2. Day Trading Strategy Steps
    Trading Strategies

    Day Trading Strategy Steps

  3. The Top Technical Indicators For Options ...
    Options & Futures

    The Top Technical Indicators For Options ...

  4. Understanding The Bond Behemoth That ...
    Mutual Funds & ETFs

    Understanding The Bond Behemoth That ...

  5. Basics of Algorithmic Trading: Concepts ...
    Trading Strategies

    Basics of Algorithmic Trading: Concepts ...

Trading Center