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The table below shows the costs, as of Friday's close, of hedging the most actively-traded (by dollar volume) New York Stock Exchange stocks against greater-than-20% declines over the next several months, using the optimal puts for that.


For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (NYSEARCA:SPY), the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) and the Nasdaq 100-tracking ETF PowerShares QQQ Trust ETF (NASDAQ:QQQ) against the similar declines. First, a reminder about what optimal puts mean in this context and why I've used 20% as a decline threshold.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. With Portfolio Armor (available in Seeking Alpha's Investing Tools Store and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary in October 2008:

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

Hedging costs as of Friday's close

The data in the table below is as of Friday's close.



Cost of Protection (as % of position value)


SPDR S&P 500


(DIA) SPDR Dow Jones Industrial Avg 1.30%***
(QQQ) PowerShares QQQ Trust 1.57%***
(NYSE:BAC) Bank of America Corporation 2.74%**


Medco Health Solutions, Inc.


(NYSE:C) Citigroup Inc. 2.81%***
(NYSE:JNJ) Johnson & Johnson 0.66%*


JPMorgan Chase & Co.


(NYSE:XOM) Exxon Mobil Corporation 1.37%*
(NYSE:CVS) CVS Caremark Corporation 1.52%**




(NYSE:HPQ) Hewlett Packard Co. 2.44%**


Goldman Sachs Group Inc.


(NYSE:WFC) Wells Fargo & Co. 2.31%*
(NYSE:AIG) American International Group Inc. 3.77%**
(NYSE:MOS) The Mosaic Company 4.85%***
(RKT) Rock Tenn Co. 3.09%*
(NYSE:PFE) Pfizer Inc. 2.53%***
(NYSE:RL) Polo Ralph Lauren Corporation 2.53%*
(NYSE:GE) General Electric Company 2.21%***
(NYSE:IBM) International Business Machines 0.97%*
(NYSE:T) AT&T Inc. 1.25%*

*Based on optimal puts expiring in October, 2011.

**Based on optimal puts expiring in November, 2011.

***Based on optimal puts expiring in December, 2011.

Disclosure: I am long some puts on DIA