Higher Hedging Costs for Most Foreign Telecoms
In an article published on Monday ("Hedging Korean Equities as News of Kim Jong-Il's Death Breaks"), one of the stocks we looked at was SK Telecom Co., Ltd (SKM). As we noted in that article, the cost of hedging that telecom against a greater than 20% drop over the next several months, using optimal puts, was 6.72% of position value. I was curious how that compared to the hedging costs of other foreign telecoms, so I attempted to calculate those costs for 10 of them. Two of them were too expensive to hedge using 20% decline thresholds, but the costs of hedging the other eight are listed in the table below. As you'll see, Korea's SK Telecom turns out to be one of the lesser expensive telecom stocks to hedge.
For comparison purposes, the table also shows the cost of hedging an American telecom, AT&T, Inc. (T) , and the Utilities Select Sector SPDR ETF (XLU) against the same decline. First, a reminder about what optimal puts are, and an explanation of the 20% decline threshold; then, a screen capture showing the optimal puts to hedge one of these foreign telecoms, Telecom Italia SpA (TI).
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. Another way of thinking about it is this: The percentage you can tolerate losing. I've used 20% as a decline threshold for the names below. 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).
The Optimal Puts to Hedge TI
Below is a screen capture showing the optimal put option contract to hedge 100 shares of TI against a greater than 20% decline between now and June 15th, 2012, as of Monday. 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.
Why There Were No Optimal Contracts For 2 Telecom Stocks
In some cases, the cost of hedging is greater than the decline threshold you are looking to hedge against. That was the case with two of these stocks on Monday, Telecom Corp. of New Zealand (NZT), and Tele Norte Leste Participacoes, S.A., (TNE). The cost of hedging each of those stocks against a greater than 20% drop over the next several months was itself greater than 20% of position value. Because of that, Portfolio Armor indicated no optimal contracts were found for them.
Hedging Costs As Of Monday
The hedging costs below are as of intraday Monday and are presented as percentages of position value.
Cost of Protection (as % of position value)
|TEO||Telecom Argentina, S.A.||13.8%***|
|NZT||Telecom Corp. of New Zealand||No Optimal Contracts|
|NTT||Nippon Telegraph & Telephone||4.66%**|
|ATNI||Atlantic Tele-Network, Inc.||9.59%**|
|TMX||Telefonos de Mexico SAB de CV||3.82%*|
|TI||Telecom Italia SpA||16.5%**|
|TNE||Tele Norte Leste Participacoes||No Optimal Contracts|
|XLU||Utilities Select Sector SPDR||1.81%**|
*Based on optimal puts expiring in May, 2012
**Based on optimal puts expiring in June, 2012
***Based on optimal puts expiring in July, 2012