Hedging 10 Stocks With Institutional Buying And High Projected Growth

by: David Pinsen

In searching for stocks with institutional bullishness and high potential growth, I used Fidelity's stock screener to pull up a list of stocks that showed an increase in institutional ownership last quarter versus the previous quarter, and had projected 3-5 year earnings growth rates that ranked them in the top quintiles in their respective industries.

I was interested to see one of the names that came up on this screen, Rackspace Hosting (NYSE:RAX). My business happens to be a client of theirs. Judging by Rackspace's projected earnings growth rate, analysts expect a lot more businesses to use its hosting services over the next several years. The table below shows the projected growth rates for Rackspace and nine other stocks, along with the costs of hedging them against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also included the cost of hedging the SPDR Dow Jones Industrial Average ETF, (NYSEARCA:DIA). 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, SuccessFactors, Inc. (NYSE:SFSF).

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 SFSF

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of SFSF against a greater-than-20% drop between now and June 15, 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 (this is true of the rest of the names in the table below as well).

Hedging Costs As Of Friday's Close

The hedging data in the table below is as of Friday's close, and is presented as a percentages of position values. The 3-5 year projected EPS growth rates represent the median of analyst estimates for each stock.



3-5 Yr Projected EPS Growth rate

Hedging Cost

LVS Las Vegas Sands 53.1% 7.04%*
MPC Marathon Petroleum 31.5% 10.7%**
MOS The Mosaic Company 32.6% 5.07%*
RAX Rackspace Hosting 37.4% 7.44%*
WMB Williams Companies 26.5% 4.82%***
SFSF SuccessFactors, Inc. 28.8% 0.50%*
BRFS BRF-Brasil Foods S.A. 41.2% 5.55%*
SLW Silver Wheaton Corp 21.3% 8.37%*
WYNN Wynn Resorts, LTD 39.9% 7.71%*
CHU China Unicom (NYSE:HK) LTD 48.8% 6.81%**




*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

***Based on optimal puts expiring in August

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