Hedging Jim Cramer's Friday Lightning Round Recommendations

by: David Pinsen

On his Mad Money show Friday, Jim Cramer was bullish on 8 of the 11 stocks callers asked about during the show's Lightning Round, according to Scott Rutt's write-up on TheStreet.com. For 3 of the stocks callers asked about, CSX Corporation (NYSE:CSX), Booz Allen Hamilton Holding Corporation (NYSE:BAH), and Terra Nitrogen, LP (NYSE:TNH), Cramer recommended alternatives -- Union Pacific Corporation (NYSE:UNP), Accenture, Plc. (NYSE:ACN), and Deere & Company (NYSE:DE), respectively. The table below shows the costs, as of Friday's close, of hedging those 3 alternatives, plus the 8 callers' stocks Cramer was bullish on, against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) against the same decline. First, a reminder about what optimal puts are, and why I've used 20% as a decline threshold; then, a screen capture showing the current optimal puts to hedge one of the stocks listed below, Union Pacific Corporation (UNP).

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 UNP

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of UNP against a greater-than-20% drop between now and May 18, 2012. A 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.

Hedging Costs As Of Friday's Close

Aside from the SPY, listed at the bottom for comparison purposes, the names are listed in the order they were mentioned on during Friday's lightning round.



Cost of Protection (as % of position value)

(NYSE:AEE) Ameren Corporation 5.00%***
(NASDAQ:TROW) T. Rowe Price Group, Inc. 8.65%*
(NYSE:DIS) Walt Disney Co. 3.98%*
(NYSE:V) Visa, Inc. 6.41%***
(NYSE:CAT) Caterpillar, Inc. 7.33%**
(NYSE:AA) Alcoa, Inc. 10.5%*
(NYSE:F) Ford Motor Co. 8.80%***
(DE) Deere & Company 7.85%***
(NYSE:PSA) Public Storage 5.97%***
(ACN) Accenture, Plc. 4.75%**
(UNP) Union Pacific Corporation 4.86%**


SPDR S&P 500


*Based on optimal puts expiring in April, 2012.

**Based on optimal puts expiring in May, 2012.

***Based on optimal puts expiring in June, 2012.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.