Hedging 5 VectorVest 'Prudent Performers'

by: David Pinsen

"Prudent Performers" is a screen VectorVest uses to find stocks with above average safety (relative safety), above average price appreciation potential (relative value), and projected growth rates above 15%. Specifically, the screen looks for stocks meeting these criteria:

  • Share price above $1
  • 50-day moving average volume of at least 100,000 shares traded
  • 1-3 Year Projected Growth Rate of 15% or higher
  • Relative value of at least 1.25 (on a scale from 0-2, with 2 being best)
  • Relative safety of at least 1.15 (on a scale from 0-2, with 2 being best)

Recall that relative safety is a measure of risk VectorVest calculates based on its analysis of the consistency and predictability of a company's financial performance, debt to equity ratio, sales volume, business longevity, price volatility and other factors. And relative value is an indicator of long-term price appreciation potential VectorVest calculates based on its analysis of projected price appreciation three years out, AAA Corporate Bond Rates, and risk.

The table below shows the top five stocks that come up on this screen currently, along with the costs, as of Friday's close, of hedging them against greater-than-21% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the cost of hedging the PowerShares QQQ Trust ETF (NASDAQ:QQQ) against the same decline, using optimal puts. First, a reminder about what optimal puts are, and a note about the decline threshold we're using here. Then, a screen capture showing the optimal puts to hedge one of the 'Prudent Performers' below, Apple Inc. (NASDAQ:AAPL).

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" 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). Often, I use 20% thresholds when hedging equities, but one of these stocks, Green Mountain Coffee Roasters (NASDAQ:GMCR), was too expensive to hedge using a 20% threshold (i.e., the cost of hedging it against a greater-than-20% drop was itself greater than 20%, so Portfolio Armor indicated that no optimal contracts were found for it). There were optimal puts available for GMCR using a 21% threshold, so that's the one I've used for all of the names here.

The Optimal Puts For AAPL

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of AAPL against a greater-than-21% 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 Friday's Close

The hedging costs below are as of Friday's close and are presented as percentages of position values. Note that a couple of these names have extremely high hedging costs, despite them having better than average relative safety scores. If you own these stocks as part of a diversified portfolio, and are content to let that diversification ameliorate your stock-specific risk, but are still concerned about market risk, you may want to consider buying optimal puts on an index-tracking ETF (such as QQQ) instead, as a way to hedge your market risk.



Hedging Cost

AAPL Apple, Inc. 1.57%*
SCSS Select Comfort Corporation 18.5%**
ODFL Old Dominion Freight 5.36%*
GMCR Green Mountain Coffee 19.7%**
GRA W.R. Grace & Co. 6.57%**
QQQ PowerShares QQQ Trust 2.18%**

*Based on optimal puts expiring in July
**Based on optimal puts expiring in September

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