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In an article published last week ("Steven Cohen And Insiders Are Bullish About These Stocks"), Seeking Alpha contributor Insider Monkey surveyed a list of 8 stocks that had at least one insider buying, and were also owned by Steven A. Cohen's hedge fund SAC Capital. Adding the criteria of insider buying was a good idea, as SAC Capital's ownership of a stock doesn't necessarily imply long- or even medium-term conviction on Cohen's part. As Bloomberg Markets Magazine put it in an article two years ago ("Steve Cohen's Trade Secrets"),

Cohen doesn't so much own stocks as rent them: He typically holds positions for 2 to 30 days, although some might remain on the books for six months or more

In this article, we'll look at the current costs of hedging these 8 stocks. The table below shows the costs, as of Tuesday's close, of hedging them against greater-than-25% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the costs of hedging the PowerShares QQQ Trust ETF (NASDAQ:QQQ) against the same decline, using optimal puts. First, a reminder about what optimal puts are, plus a note about the 25% decline threshold; then, a screen capture showing the optimal puts for one of the comparsion ETF QQQ.

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've used 25% thresholds for each of the names below.

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-25% 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 (the same is true about 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

EQT EQT Corporation 3.70%*
NIHD NII Holdings, Inc. 5.31%*
VMW VMware, Inc. 5.48%**
BBY Best Buy Co. Inc. 3.56%*
EXXI Energy XXI (Bermuda) Ltd. 6.88%*
INCY Incyte Corporation 10.6%*
WFC Wells Fargo & Company 3.65%**
ETFC E*Trade Financial Corporation 8.15%**

QQQ

PowerShares QQQ

1.06%*

*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

Source: Hedging 8 SAC Capital Holdings With Insider Buying