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. How long are credit ratings valid?

    Learn how credit ratings are issued and how long they are valid. Investors look to credit ratings to determine risk associated ...
  2. Does a good credit rating guarantee repayment?

    Learn how credit ratings help investors determine the creditworthiness of an issuer and the risk associated with making an ...
  3. What are some examples of the most common assets on a Roth IRA?

    Investing in a Roth IRA can be achieved by using a variety of assets. Cash, real estate, stocks, bonds and other investments ...
  4. Can I invest my IRA in an entity, business or LLC?

    Explore different types of businesses, entities, corporations and limited liability companies, and the types IRA-eligible ...
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 Top Reasons Behind The U.S. National ...
    Economics

    The Top Reasons Behind The U.S. National ...

  2. Technical Analysis Strategies for Beginners
    Trading Strategies

    Technical Analysis Strategies for Beginners

  3. Junk Is Starting To Look A Lot Less ...
    Stock Analysis

    Junk Is Starting To Look A Lot Less ...

  4. 3 ETF Signals You May Use For Confirmation
    Economics

    3 ETF Signals You May Use For Confirmation

  5. Are All ETF Correlations Barreling Towards ...
    Mutual Funds & ETFs

    Are All ETF Correlations Barreling Towards ...

Trading Center