Hedging 5 Stocks That Rose on Unusual Volume Tuesday
On Tuesday, a day when the Nasdaq Composite rose fractionally, nineteen Nasdaq stocks rose on increases in their daily volumes of more than 100%. In this post, we're going to look at the hedging costs of five of those stocks that rose on increases in volume of 179% or more. Of these five, one in particular, Solazyme, Inc. (NASDAQ:SZYM), was extremely expensive to hedge using optimal puts. Recall that we've observed examples where high optimal hedging costs presaged poor performance. The table below shows the costs, as of Tuesday's close, of hedging Solazyme and four other stocks that rose on unusual volume Tuesday against greater-than-28% declines over the next several months, using optimal puts.
For comparison purposes, I've also added the costs of hedging the Nasdaq 100-tracking ETF PowerShares QQQ Trust ETF (NASDAQ:QQQ). First, a reminder about what optimal puts are, and a note about why I've used 28% as a decline threshold here; then, a screen capture showing the optimal puts to hedge one of the stocks below, PriceLine.com, Inc. (NASDAQ:PCLN).
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" 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% decline thresholds when hedging equities, but one of these stocks, Solazyme, Inc., was too expensive to hedge using a 20% threshold (i.e., the cost of hedging it against a 20% decline was itself more than 20% of position value, so Portfolio Armor indicated there were no optimal contracts available for it). There were optimal contracts for all of these names against a 28% threshold, so that's the decline threshold I've used here.
The Optimal Puts For PCLN
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of PriceLine.com, Inc. against a greater-than-28% drop between now and July 20th. 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 slightly 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 Tuesday's Close
Aside from the ETF listed at the bottom for comparison purposes, the stocks below are listed in descending order of their volume changes on Tuesday. The increases in volume for these stocks ranged from a 297% increase for Chart Industries, Inc. (NASDAQ:GTLS), to a 179% increase for Sina Corporation (NASDAQ:SINA). Hedging costs below are presented as percentages of position value.
As we noted above, one of these names (Solazyme, Inc.) was extremely expensive to hedge; as you'll see below, another two names had double digit hedging costs at this threshold. 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.
|GTLS||Chart Industries, Inc.||5.57%**|
|QQQ||PowerShares QQQ Trust||1.19%**|
*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.