(June 8th, 2012) With economic data softening worldwide and the seemingly never-ending crisis in Europe flaring up once again, it makes sense that investors would want to exercise caution. With that in mind, I’d like to present a strategy that involves multiple investment vehicles and is meant for longer-term income-oriented investors. It is not possible to execute the strategy on every public company’s capital structure. But, when you do find the right combination of bond prices and option premiums for a certain company, this strategy will allow you to capture the higher yields that occur when corporate bond spreads widen while hedging away the credit risk for a certain period of time.
As investors in the steel industry know, recessions can be particularly brutal on the stocks of steel companies. One company exposed to the cyclicality of the steel industry is U.S. Steel (X). If you are interested in this company but are concerned with the possibility of a world-wide recession further crushing its already beat up stock and possibly putting its business at risk, you might consider doing the following instead: buy a senior unsecured bond and hedge away the risk by buying put options on U.S. Steel’s stock. The expiration date on the put options should be far enough into the future that it covers the time period during which you fear a recession or a risk to the business is possible.
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