Hedging 7 Stocks That Beat Estimates This Week

 |  Includes: CPB, DE, DSX, DY, HPQ, MDT, YGE
by: David Pinsen

Hedging 7 Stocks with positive earnings surprises this week

In the run-up to Thanksgiving, by Wednesday's close, 30 stocks had released earnings that beat their consensus estimates this week. The table below shows the actual earnings, the consensus estimates, and the costs-- as of Wednesday's close-- of hedging 7 of these stocks against greater-than-32% 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). First, a reminder about what optimal puts are, plus a note about why I've used 32% as a decline threshold here; then, a screen capture showing the current optimal puts for one of the companies below, Campbell Soup Company (CPB).

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" 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). Usually, I use 20% decline threshold when hedging equities, but Yingli Green Energy Holding Co. Ltd. (YGE) was too expensive to hedge using a 20% threshold (i.e., the cost of hedging it against a 20% decline was itself more than 20% of position value, so Portfolio Armor indicated there were no optimal contracts available for it). The smallest decline threshold against which it was possible to hedge YGE was 32%, so that's the decline threshold I've used for all of the names in the table below.

The Optimal Puts For CPB

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of CPB against a greater-than-32% 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.

Click to enlarge

Hedging Costs As Of Wednesday's Close

The hedging data below is as of Wednesday's close, and is presented as percentages of position value. The "Actual" column shows the stocks' actual earnings announced this week, and the "Estimate" column shows what the consensus estimates were for them.



Actual Estimate

Hedging Cost

YGE Yingli Green Energy Holding Co. Ltd. $0.13 $0.01 31.6%**
DE Deere & Company $1.62 $1.44 4.08%**
DSX Diana Shipping, Inc. $0.33 $0.31 8.81%**
DY Dycom Industries $0.38 $0.30 23.5%**
CPB Campbell Soup $0.82 $0.80 0.80%*
MDT Medtronic Inc. $0.84 $0.82 1.74%*
HPQ Hewlett Packard $1.17 $1.13 4.23%*


SPDR S&P 500


Click to enlarge

*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.