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Most investors separate options from bonds in thinking about the two. They shouldn’t, because bonds are puts that can acquire time-value about which a decision can be made (though it needn’t). By convention, the strike of a bond is par, and expiration is maturity. By default, exercise is European. But over the course of a holding-period, a bond can trade above its strike, and a holder can capture time-value by selling his put. When should he sell to capture time-value, and when not? More broadly, when should he sell to capture available cap-gains (of which time-value is subset)?

Three philosophies (not necessarily mutually exclusive) suggest themselves: (1) “Stick to your plan.” (2)“Don’t let the market take back gains, whatever their source.” (3) “Rotate inventory.” If all other things are equal, an in-the-money put trends upward toward its strike, and an out-of-the-money put trends downward. Thus, cap-gains can persist, but time-value is a wasting asset.

Here’s an example where both time-value and cap-gains were captured by selling, instead of holding to maturity. A lot of Union Carbide’s 7.75’s of ’96 came on the market last spring, and I pick up some 04/10/10 at 86.970 for a YTM of 8.9%. That’s not the best of yields, given that Union Carbide/Dow Chem is a piece of trash, bottom of the barrel company in terms of financial strength and moral integrity. But money is money, and I did the trade, because the discount to par was attractive. Recently, Union Carb held a Dutch auction, and I chose to tender. Settlement was yesterday, at 106.585. So, the YTM for my holding-period became 30.5%. That’s not too shabby for an early exit that captured all available intrinsic-value, plus some time-value.

Footnote: Union Carbide is a wholly owned subsidiary of Dow Chem with a long history of killing its workers (Hawks Tunnel) and community members (Bhopal). To buy its stock or bonds is take a stance on the issue of Socially Responsible Investing (whose pros and cons can be argued elsewhere). But at the very least, it is “dirty money”.
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