Hedging 5 'Industry Stars'

Includes: CTB, DV, MGA, ON, SAPE, VTI
by: David Pinsen

The "Industry Stars" screen by Recognia, Inc. is designed to find the best candidates within different industries based on a combination of quantitative and qualitative measures. The screen looks for stocks that are First Call consensus "buy" recommendations and exhibit bullish technical patterns. Additionally, the screen requires stocks to meet several fundamental criteria, primarily including the following:

  • PEG Ratio: Lowest 60% for industry
  • Price/Sales Ratio: Lowest 60% for industry
  • EPS growth (5 year historical): Highest 60% for industry
  • Return on Equity: Highest 60% for industry
  • Current Ratio: Highest 60% for industry

On Wednesday, seven stocks made the Industry Stars screen. The table below shows the costs, as of Wednesday's close, of hedging the five most actively-traded of those seven stocks against greater-than-20% declines over the next several months, using optimal puts. As the table below shows, some of these stocks are quite expensive to hedge. If you own them as part of a diversified portfolio, and are content to let your diversification ameliorate your stock-specific risk -- but you are still concerned about market risk -- you might consider buying optimal puts on an index-tracking ETF instead, as a hedge against market risk.

A Comparison

For comparison purposes, I've added the Vanguard Total Stock Market Index ETF (NYSEARCA:VTI) to the table. First, a reminder about what optimal puts are, and a note about decline thresholds. Then, a screen capture showing the optimal puts to hedge the comparison ETF, VTI.

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% decline thresholds for all of the names here.

The Optimal Puts for VTI

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of the Vanguard Total Stock Market ETF against a greater-than-20% decline between now and September 21st. A note about these optimal put options and their cost: To be conservative, the app 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).

Hedging Costs as of Wednesday's Close

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



Hedging Cost

FCS Fairchild Semiconductor 10.5%**
CTB Cooper Tire & Rubber Co 10.1%**
DV Devry, Inc. 8.76%**
SAPE Sapient Corporation 12.2%*
MGA Magna International, Inc. 6.83%***


Vanguard Total Stock Mkt


*Based on optimal puts expiring in July
**Based on optimal puts expiring in August
***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.