By Brad Zigler
Real-Time Monetary Inflation (Last 12 Months): 1.1%.
Yesterday was an object lesson in systematic risk. Tuesday, the U.S. markets played catch-up with the Mideast turmoil after the Presidents Day holiday. Metals and oil shot up while equities tumbled.
Some stocks slid further than others. Among the hardest-hit were agribusiness issues, off nearly 4% against the S&P 500's 2% slide. Equity market risk wasn't the only drag on ags, though. The commodities in which many agribusiness companies deal also slipped 2% on Tuesday.
That much-touted commodity stock leverage (think gold miners) that worked so well until a year ago is now working against ags. Agribusiness stocks' relative strength over commodity futures started to break down in March 2010 and, after attempts to reestablish itself, appears likely to break down further.
Relative Strength: Agribusiness Stocks vs. Futures
The recent wobbliness in agribusiness stocks was telegraphed at the top of the month when put prices on the Market Vectors Agribusiness ETF (NYSEARCA:MOO) started inflating (see "Agribusiness Stocks Show Worrying Signs"). If nothing else, holders of ag stocks, or the ETF proxy, are nervous enough now to hedge their positions with puts.
The thinking behind the hedge is simple. Adding a put to a long stock position effectively transforms stock or ETF ownership into call ownership. Suppose, for example, you bought the MOO fund at $50 back in December. You've got, ostensibly, $50 of risk in the position and an unlimited upside. If you become nervous about the ag sector's near-term prospects, but don't want to take a short-term capital gain (MOO's now trading around $54), you could buy a $50 May put for 75 cents a share.
That 75 cents ($75 per 100-share contract) gives you the right, but not the obligation, to sell your MOO shares at $50 through mid-April, no matter the fund's actual market price. Even if the fund shares sink to oblivion, you can "put" the shares to the option grantor at 50 bucks. Your breakeven on the deal - at the put's expiration date - is $50.75. At any MOO price above that, you make money. In fact, you've retained the unlimited upside of the long ETF position, reduced only by the put premium paid. If, for example, you expected MOO to hit $57 by Tax Day, you'd make $7 a share with the naked stock. Hedged with the put, you'd make $6.25. At $58, the differential results would be $8 vs. $7.25. And so on.
With a judicious protective put purchase, you can afford to hold a long ETF or stock position until you reach your upside price objective or cross the threshold for long-term capital gain/loss treatment.
MOO put premiums peaked, relatively speaking, back on Feb. 11. They're comparatively cheap now, but may not remain so. After all, MOO is down another 2.6% today.
We'd like to get a consensus from the holders of the MOO ETF. Let us know what you're going to do here - go naked with your long fund position or hedge with puts?