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 do I invest or trade market indicators?

    Read about how investors can trade actual market indicators, such as the S&P 500 Index, rather than specific stocks or commodities.
  2. Can individual investors profit from interest rate swaps?

    Find out how individual investors can speculate on interest rate movements through interest rate swaps by trading fixed rate ...
  3. What is a common strategy traders implement when using the Wide-Ranging Days pattern?

    Learn about wide-ranging days and how traders use this single-session candlestick pattern to predict trend reversal and create ...
  4. How do I compare one junk bond to another?

    Discover how to identify, select and compare junk bonds. Learn the role that risk, yield and opportunity cost play in investing ...
RELATED TERMS
  1. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  2. Next Generation Fixed Income (NGFI) Manager

    A Next Generation Fixed Income (NGFI) manager is a fixed income ...
  3. Next Generation Fixed Income (NGFI)

    Next generation fixed income is an innovative approach to investing ...
  4. Indicator

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

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

    Several classes of noninvestment grade bonds held by an insurance ...

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    How do I invest or trade market indicators?

  2. Chart Advisor

    Is Now the Time to Invest in North America?

  3. Chart Advisor

    These Oil Service Stocks Are Ready For ...

  4. Trading Strategies

    The Top Five Stocks For Novice Swing ...

  5. Options & Futures

    Advantages Of Trading Futures Over Stocks

Trading Center