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Volatility remains high globally on Europe concerns

The S&P 500 Volatility Index (VIX) dropped 5.45% on Thursday, closing at 38.84. Volatility remained elevated in Europe and Asia as well, with the Euro Stoxx 50 VStoxx Index and the Hang Seng HSI Volatility Index both closing over 40. Reporters Cecile Vannucci and Jeff Kearns at Bloomberg attributed the rise in volatility to fears of "Europe infection." Hedging costs of the widely traded foreign stocks we track were high as well. The table below shows the costs as of Thursday's close of hedging those foreign stocks, each of which trades in the U.S., against greater-than-20% declines over the next several months, using optimal puts.

Comparisons

For comparison purposes, we've also included the costs of hedging the SPDR S&P 500 Trust ETF (SPY), the SPDR Dow Jones Industrial Average ETF (DIA), the Vanguard Emerging Markets ETF (VWO), and the Vanguard Europe Pacific ETF (VEA) against the same declines (underlining the fears about Europe, the costs of hedging the Vanguard Europe Pacific ETF were considerably higher than those of hedging Vanguard's emerging markets ETF). 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 to hedge one of the foreign stocks listed below, Teva Pharmaceuticals (TEVA).

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.

Decline Thresholds

In this context, "threshold" refers to 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 TEVA

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of TEVA against a greater-than-20% drop between now and March, 16, 2012. One note 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.

(Click charts to enlarge)



Hedging Costs as of Thursday's close

Data in the table below as of Thursday's close.

Symbol

Name

Cost of Protection (as % of position value)

(NYSE:AMX)

America Movil SA de CV

5.76%*

(NYSE:TEVA) Teva Pharmaceuticals 5.74%**

(UBS)

UBS AG

14.8%**

(NYSE:VALE) Vale S.A. 10.1%**
(NASDAQ:BIDU) Baidu, Inc. 19.6%**

(NYSE:PBR)

Petrobras

12.0%*

(NYSE:ITUB) Itau Unibanco Holding S.A. 12.1%**
(NASDAQ:VOD) Vodafone Group plc 5.74%***

(NYSEARCA:VWO)

Vanguard Emerging Markets ETF

10.3%**

(NYSEARCA:VEA) Vanguard Europe Pacific ETF 18.9%**

(NYSEARCA:SPY)

SPDR S&P 500

4.00%**

(NYSEARCA:DIA) SPDR Dow Jones Industrial Avg. 3.73%**

*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 am long puts on DIA.

Source: Hedging Costs Rise For Widely Traded Foreign Stocks