Hedging 6 of Whitney Tilson's Top Holdings
Whitney Tilson's Tilson Focus fund (TILFX) had a rough year in 2011 (down 21.5%), but, as the chart below shows, it is up year-to-date in 2012.
Of the top ten holdings in the Tilson Focus Fund, six have options traded on them. For this post, we looked at the current costs of hedging those six stocks with optimal puts. One stock in particular, NelNet, Inc. (NNI), stood out for its high optimal hedging cost -- recall that we've observed examples where high optimal hedging costs presaged poor performance.
The table below shows the costs of hedging NelNet, Inc., and the five other optionable Tilson Focus Fund top holdings against greater-than-20% declines over the next several months, using optimal puts.
For comparison purposes, I've added the SPDR S&P 500 Trust ETF (SPY) to the table below. First, a reminder about what optimal puts are, and an explanation about decline thresholds; then, a screen capture showing the optimal puts to hedge one of the names below, Berkshire Hathaway, Inc. (BRK.B).
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" refers to the maximum downside 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've used 20% thresholds for each of the names below.
The Optimal Puts for BRK-B
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of BRK-B 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 for the rest of the names below).
Hedging Costs as of Thursday's Close
The hedging data in the table below is as of Thursday's close, and is presented as percentages of position values.
|HHC||The Howard Hughes Corp.||4.65%**|
|BRK.B||Berkshire Hathaway, Inc.||1.14%*|
|BUD||Anheuser-Busch Inbev SA||2.83%*|
|SPY||SPDR S&P 500||1.05%*|
*Based on optimal puts expiring in June
**Based on optimal puts expiring in July
***Based on optimal puts expiring in August