Can anyone give me a hand? I actually did the conversion math correctly but not understanding selling short in this scenario. Thanks in advance!
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Hi @Keturah, here’s the relevant part from the explanation with emphasis:
The investor needs to liquidate the investment now, so holding the preferred or common shares longer is not an option. This eliminates two answers; the only real options are to sell the preferred shares or convert to common stock and sell those shares. Selling the preferred shares provides an overall value of $18,620 (200 preferred shares x $93.10). The other option is to sell short the common stock immediately (to lock in the current price), then to convert the preferred shares to common stock to cover the short position (essentially the equivalent of converting and selling the common shares). 200 preferred shares can be converted into 400 shares of common stock (2:1 conversion ratio) worth $56.63, resulting in an overall value of $22,652. Converting the shares results in a higher payout, making it the best choice.
Since the market is constantly moving, the investor must place an order to sell common shares short to lock in the current market price. Otherwise it might fluctuate in the time it takes to convert and sell the existing shares. Once the existing shares are converted and settled, they will cover the short position and the strategy will be completed.
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Got it! Thanks Justin!
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