Hedging Groupon and other leading Internet stocks
Now that options are traded Groupon Inc. (NASDAQ:GRPN), it's possible to hedge it with protective puts -- possible, but extremely expensive to do so. Groupon investors concerned about downside risk may want to consider simply selling some of their shares instead. The only Internet stock I've seen that's as expensive or more to hedge now is another one that went public this year, Pandora Media, Inc. (NYSE:P). The table below shows that, as well as the costs, as of Thursday's close, of hedging several other leading Internet stocks against greater-than-35% declines over the next several months, using optimal puts.
For comparison purposes, I've also added the cost of hedging the PowerShares QQQ Trust ETF (NASDAQ:QQQ) against the same decline. First, a reminder about what optimal puts are, and a note about why I've used 35% as a decline threshold this time; then, a screen capture showing the optimal puts to hedge Groupon, Inc.
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.
In this context, "threshold" is the maximum decline you are willing to risk. 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). In the past, when looking at the hedging costs of Internet stocks I've used 25% decline thresholds, but Groupon, Inc. and Pandora Media, Inc. were too expensive to hedge against greater-than-25% declines (i.e., the cost of hedging them against 25% declines was itself more than 25% of position value, so Portfolio Armor indicated there were no optimal contracts available for them). 35% was the smallest decline threshold for which there were optimal contracts for all of these stocks, so that's the decline threshold I've used here.
The optimal puts for GRPN
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of GRPN against a greater-than-35% drop between now and April 20, 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 Thursday's close
The table below shows the costs of hedging these stocks against greater-than-35% declines over the next several months, as of Thursday's close.
Cost of Protection (as % of position value)
|P||Pandora Media, Inc.||32.6%***|
|QQQ||PowerShares QQQ Trust||1.90%***|
- *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.