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Seeking Alpha contributor David Hunkar included a graphic in a recent article of his ("The 10 Most Traded ADRs on the NYSE, Nasdaq, and OTC in 2011") that illustrated a couple of interesting points. One was how Russian companies dominate depository receipt trading on the London Stock Exchange. The other was how, in the U.S., the volume of the 10 most traded American Depository Receipts (ADRs) on the NYSE dwarfs that of the top-10 ADRs on the Nasdaq and OTC markets. In this post, we'll look at the current costs of hedging the 10 most traded ADRs on the NYSE. The table below shows the costs, as of Tuesday's close, of hedging them against greater-than-26% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the cost of hedging the iShares MSCI EAFE Index ETF (NYSEARCA:EFA) against the same decline, using optimal puts. First, a reminder about what optimal puts are, plus a note about why I've used a 26% decline threshold here; then, a screen capture showing the optimal puts for one of these ADRs, Cemex, S.A.B. de C.V. (NYSE:CX).

About Optimal Puts

Puts are options that give an investor the right, but not the obligation, to sell a particular security at a specified price (the strike price of the option), on or before a certain date (the expiration date of the option). As such, the puts can offer protection for investors that own a security. 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). I often use 20% thresholds when hedging equities, but Alcatel-Lucent (NYSE:ALU) and Cemex, S.A.B. de C.V. were too expensive to hedge using 20% thresholds (i.e., the cost of hedging them against greater-than-20% declines was itself greater than 20%, so Portfolio Armor indicated no optimal contracts were found for them). It was possible to hedge all of the names against greater-than-26% declines, so that's the decline threshold I've used here.

The Optimal Puts For CX

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of Cemex against a greater-than-26% drop between now and July 20th. 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 (the same is true for the other names in the table below).

Hedging Costs As Of Tuesday's Close

The hedging costs below are as of Tuesday's close and are presented as percentages of position values.

Symbol

Name

Hedging Cost

NOK Nokia Corporation 14.3%**
ALU Alcatel-Lucent 18.5%*
VALE Vale, S.A. 10.5%*
PBR Petroleo Brasileiro S.A. 3.57%**
TSM Taiwan Semiconductor 5.81%**
ITUB Itau Unibanco Holding S.A. 3.56%*

CX

Cemex, S.A.B. de C.V.

17.2%**

BBD Banco Bradesco, S.A. 3.34%*
BP British Petroleum 2.23%**
GGB Gerdau, S.A. 7.79%*
EFA iShares MSCI EAFE Index ETF 1.52%*

*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

Source: Hedging The 10 Most Traded ADRs On The NYSE