Ten Stocks That Advanced on Unusual Volume
On a day when the major market indexes were up on positive news about Europe, several stocks rose on unusual volume. The table below shows the costs, as of Tuesday's close, of hedging 8 of 10 stocks that advanced on unusually heavy volume against greater-than-20% declines over the next several months, using optimal puts.
For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) and the Nasdaq 100-tracking ETF PowerShares QQQ Trust ETF (NASDAQ:QQQ). First, a reminder about what optimal puts are, and why I've used 20% as a decline threshold here; then, a screen capture showing the optimal puts for one of the comparison ETFs, SPY.
About Optimal Puts
Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.
"Threshold," in this context, is the maximum decline you are willing to risk in the value of your position in a security. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 20% thresholds for each of the securities below. Essentially, 20% is a large enough threshold that it reduces the cost of hedging, but not so large that it precludes a recovery.
The Optimal Puts For SPY
Here is a screen shot showing the optimal put option contracts to buy to hedge 100 shares of SPY against a greater-than-20% drop between now and March, 16, 2012. Two notes about these optimal put options and their cost:
- To be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask.
- As volatility has climbed, so have hedging costs. On July 19, when the VIX was at 19.21, the cost of hedging SPY against a greater-than-20% decline over the next six months was 1.53% of position value, as we noted in this post published the following day. As the screen shot below shows, on Tuesday, the cost of hedging SPY against the same decline over about the same time frame was 3.86%.
(Click to expand)
Why There Were No Optimal Puts for TPCG or IMGN
In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with TPC Group, Inc. (NASDAQ:TPCG) and Immunogen Inc. (NASDAQ:IMGN). As of Tuesday, the cost of protecting against a greater-than-20% decline in each of those stocks over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for them.
Hedging Costs As Of Tuesday's Close
Below the ETFs listed for comparison purposes, the stocks below are listed in order of volume change Tuesday, with the one with the most unusually high volume, Nuance Communications, Inc., listed first.
The hedging costs for most of these stocks seem quite high, even considering high current market volatility. In an article last month, we speculated about whether high optimal hedging costs (relatively speaking) might constitute a red flag.
Cost of Protection (as % of position value)
SPDR S&P 500
|QQQ||PowerShares QQQ Trust||4.07%**|
|NUAN||Nuance Communications, Inc.||10.3%***|
|GIVN||Given Imaging Ltd.||8.59%*|
|MLHR||Herman Miller Inc.||15.7%*|
|TPCG||TPC Group, Inc.||No Optimal Contracts|
|SAFM||Sanderson Farms, Inc.||6.79%*|
|MBFI||MB Financial, Inc.||14.06%*|
|CMTL||Comtech Telecom Corp.||13.8%***|
|IMGN||Immunogen Inc.||No Optimal Contracts|
|FCFS||First Cash Financial Services Inc.||7.39%**|
*Based on optimal puts expiring in February, 2012
**Based on optimal puts expiring in March, 2012
***Based on optimal puts expiring in April, 2012
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.