3D Systems Slides
You're bullish on 3D Systems - otherwise you wouldn't own it, right? But maybe you've been thinking of adding downside protection after reading Seeking Alpha contributor Investment Standard warning of DDD's increasing competition from HP (NYSE:HPQ), GE (NYSE:GE), and Autodesk (NASDAQ:ADSK), and declining revenue from its 3D printers. Or maybe Seeking Alpha contributor Jeff Opdyke's warning that stocks are too late for rescue has you feeling a bit cautious.
Granted, you've been reading similar warnings about the market being over-extended for years, and if you moved to cash the first time you read one, you would have missed out on years of a bull market. But still, you figure the bull market does seem long in the tooth, so maybe staying long while adding downside protection might make sense.
We went on to present a cost-effective hedge for DDD. Since then, the stock has slid.
Let's look back at the optimal collar hedge we presented for DDD last month and see how it has reacted to the drop.
The September 28th Optimal Collar Hedge:
As of September 28th's close, this was the optimal collar to hedge 1,000 shares of DDD against a greater-than-16% drop by mid-February while not capping an investor's upside at less than 12% by the end of that time period (screen captures via the Portfolio Armor iOS app).
As you can see at the bottom of the screen capture above, the cost was $100, or 0.56% of position value (calculated conservatively, using the ask price of the puts and the bid price of the calls) when opening the hedge.
How The September 28th Collar Responded To DDD's Drop
Here's an updated quote on the put leg as of Tuesday's close:
And here is an updated quote on the call leg:
How That Hedge Ameliorated DDD's Drop
DDD closed at $17.73 on Wednesday, September 28th. A shareholder who owned 1,000 shares of it and hedged with the collar above then had $17,730 in DDD shares plus $1,330 in puts, and if he wanted to buy-to-close his short call leg, he would have needed to pay $1,230 to do that. So, his net position value on September 28th was ($17,730 + $1,330) - $1,230 = $17,830.
DD closed at $14.82 on Thursday, October 13th, down about 16.5% from its closing price on September 28th. The investor's shares were worth $14,820 as of 10/13, his put options were worth $2,250, and if he wanted to close out the short call leg of his collar, it would have cost him $535, using the midpoint of the spread, in both cases. So: ($14,820 + $2,250) - $535 = $16,535. $16,535 represents a 7.3% drop from $17,830.
More Protection Than Promised
So, although DDD had dropped by about 16.5% at the time of the calculations above, and the investor's hedge was designed to limit him to a loss of no more than 16%, he was actually down 7.3% on his combined net hedge plus underlying stock position by this point. As with the gold miners crash and the plunge in Alcoa (NYSE:AA) earlier this month, this illustrates the impact of time value on a hedge designed to protect based on its intrinsic value alone.
Reader "Mr. Balboni" suggests 3D Systems is in for a bounce. Squeeze Metrics seems to agree (we have an affiliate relationship with Squeeze Metrics and are compensated if a reader joins the site). On Thursday, we received this email from the site:
Looks like there was some unusual dark pool activity in some of the tickers you follow.
DDD had a DPI of 67%.
Click through to your dashboard for more info: here
"DPI" refers to the Dark Pool Indicator, which looks at the ratio between institutional buying and selling in dark pools (private exchanges where institutions trade): A high DPI means most of the dark pool volume is institutional buying, and a low DPI means most of the dark pool volume is institutional selling. But having a high DPI alone doesn't trigger one of those emails, the security also has to have had a one standard deviation increase in dark pool activity over its 120-day average. Logging into the site, we pulled up this chart:
Thursday is highlighted, so you see the 67% DPI. The other figure you can see there is GEX, which refers to gamma exposure. GEX essentially measures how many shares of DDD option market makers will have to buy if the stock rises 1%. In this case, they would have to buy 52,614 shares (for detailed explanation of this dynamic, see this article on Deutsche Bank (NYSE:DB)).
If you're long DDD and are bullish based on this, you can sell your appreciated puts, buy-to-close your calls to eliminate your upside cap and use the net proceeds to buy more shares. But if you're concerned about Jeff Opdyke's warning, you may want to hold on to your DDD puts to limit your downside risk over the next several months.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.