There are always companies in financial distress that have to issue very high-yielding bonds and/or preferred stock in order to raise capital. Here is a way to play these companies at risk of financial breakdown.

If the company goes under, the stock will tank and the put will profit. Of course, the preferred stock will also tank. The hope is that the put profits will offset the preferred losses. The potential benefit of using the preferred is that its income, provided they company pays it, will have helped to finance the put.

If, on the other hand, the company improves its credit standing and liquidity issues, the stock should rise. That will cause a loss - maybe a total loss - on the put. However, the preferred should move back toward par value (i.e., $25 per share) creating a potentially handsome profit. What's more, the income from the preferred will have reduced the loss on the put.

The reason we mentioned using a cumulative preferred versus a non-cumulative preferred is because it may be less volatile than the company stock. Thus, if the stock tanks and the put profits, these profits might exceed the losses on the preferred and provide the speculator with an exit opportunity if the situation gets uglier.

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