Hot Home Furnishing Stocks: Hedging The 7 Best-Rated Names

by: David Pinsen

Home Furnishing Industry Has The Second-Highest Relative Timing

In a Seeking Alpha article published two months ago ("Hedging 10 High 'Relative Timing' stocks"), we described VectorVest's Relative Timing indicator, which is a measure of technical strength. In addition to applying that to stocks, VectorVest also applies it to industry groups, by aggregating the data for the stocks within each industry group.

Sorting VectorVest's 225 industry groups by Relative Timing on Wednesday produced this somewhat surprising result: The industry group with the second-highest Relative Timing was the Home Furnishings subcategory of retail. Given the continued weakness in housing, I wouldn't have expected that. In this article, we'll look at the hedging costs for the 7 highest rated stocks in the Home Furnishings industry group.

Hedging The 7 Highest-Rated Home Furnishing Stocks

Recall that VST (Value, Safety, Timing), VectorVest's master ranking, is made up of a weighted average of its Relative Value, Relative Safety and Relative Timing indicators, with Relative Value underweighted and Relative Timing overweighted. The 7 highest rated home furnishing stocks in VectorVest's universe had VST ratings ranging from 1.22 to 1.47 (on a scale of 0 to 2). The table below shows those VST ratings, as well as the costs, as of Wednesday's close, of hedging these stocks against greater-than-24% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the cost of hedging the Nasdaq 100-tracking ETF PowerShares QQQ Trust (NASDAQ:QQQ). First, a reminder about what optimal puts are, plus a note about why I've used 24% as a decline threshold here; then, a screen capture showing the optimal puts for one of these home furnishing stocks, Williams-Sonoma Inc. (NYSE:WSM).

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 a 20% decline threshold when hedging, but one of these stocks, Cost Plus, Inc. (CPWM) 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). There were optimal contracts for all of these stocks against a 24% threshold, so that's the decline threshold I've used here.

The Optimal Puts For WSM

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of WSM against a greater-than-24% 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 Wednesday's Close

The names below are listed in order of their VectorVest VST (Value, Safety, Timing) ranking. Hedging costs are presented as percentages of position value. Aside from the ETF QQQ, listed at the bottom for comparison purposes, which is rated a "hold," the other names here are rated "buy" by VectorVest.




Hedging Cost

SCSS Select Comfort Corp. 1.47 17.7%**
ETH Ethan Allen Interiors, Inc. 1.37 10.1%*
BBBY Bed Bath & Beyond Inc. 1.30 2.39%*
PIR Pier 1 Imports, Inc. 1.30 12.2%**
CPWM Cost Plus, Inc. 1.29 23.5%*
WSM Williams-Sonoma Inc. 1.27 5.26%*
RCII Rent-A-Center Inc 1.22 11.4%**
QQQ PowerShares QQQ Trust 1.08 2.49%**

*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.