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20 Versus 11

Although the Nasdaq Composite dropped 0.51% on Friday, to close at 2,710.67, 20 Nasdaq names made new 52-week highs on the day, versus 11 that made new 52-week lows. One of the stocks that made a new high on Friday was Panera Bread Company (PNRA). Readers interested in what has made that company successful ought to take a moment to read this profile of Panera's founder and executive chairman, Ron Shaich, which appeared in the Financial Times in September, "Business Diary: Ron Shaich." That article gave sense of Shaich's near-obsession with the business. In it Shaich was quoted as saying,

I don't have hobbies. My real hobby - and love - is figuring out what works and using what I learn to make a difference. [...] Even my kids know that I'm going to stop at three Paneras and two competitors on our way out of town for a family vacation. That, to them, is normal - because I'm doing what I love.

Panera was one of 10 of the 20 stocks that made new highs Friday that had options traded on them. In this post, we'll look at the cost of hedging those ten. The table below shows the costs of hedging 8 of those 10 stocks against greater-than-20% declines over the next several months, using optimal puts (2 of those stocks were too expensive to hedge using decline threshold of 20%).

A Comparison

For comparison purposes, I've added the PowerShares QQQ Trust ETF (QQQ) to the table. First, a reminder about what optimal puts are, and why I've used 20% as a decline threshold; then, a screen capture showing the optimal puts to hedge one of the comparison ETF QQQ.

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 QQQ

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of QQQ against a greater-than-20% drop between now and June 15th. 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 of the other names in the table below).

Why there were no Optimal Contracts for ARIA or IDIX

In some cases, the cost of hedging a stock is greater than the loss you are looking to hedge against. That was the case with Ariad Pharmaceuticals, Inc. (ARIA) and Idenix Pharmaceuticals, Inc. (IDIX) on Friday: the cost of hedging those stocks against greater-than-20% declines over the next several months was itself greater than 20% of position value; because of that, Portfolio Armor indicated no optimal contracts were available for either stock at a 20% threshold.

Hedging Costs as of Friday's Close

The data below is as of Friday's close, and is presented as percentages of position values.

Symbol

Name

Hedging Cost

PNRA Panera Bread Company 6.07%***
FAST Fastenal Company 4.40%***
CBST Cubist Pharmaceuticals, Inc. 8.12%***
NUAN Nuance Communications 6.83%**
VPHM ViroPharma Inc. 16.4%***
STX Seagate Technology Plc 6.91%*
CALL MagicJack VocalTec Ltd. 14.7%*
ARIA Ariad Pharmaceuticals, Inc. No Optimal Contracts
IDIX Idenix Pharmaceuticals, Inc. No Optimal Contracts
SHFL Shuffle Master, Inc. 10.3%***

QQQ

PowerShares QQQ Trust

1.63%*

*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

***Based on optimal puts expiring in August

Source: 10 Stocks That Made New Highs On Friday: Hedging Costs