Hedging 6 'Teen' Retailers

by: David Pinsen

Hedging 6 'Teen Retailers

In a recent article ("Stacking Up 6 'Teen' Retailers"), Seeking Alpha contributor Stephan Rosenman evaluated 6 retailers based on four different criteria:

1. Profitability: Operating Margin
2. Free cash flow: Free Cash Flow/Sales
3. Growth: 3-Year Average Revenue Growth
4. Efficiency: Inventory Turnover

Based on those criteria, Rosenman found The Buckle, Inc. (NYSE:BKE) to be the most undervauled of the six retailers. In this post, we'll take a look at the hedging costs of these retailers. The table below shows the costs, as of Friday's close, of hedging Buckle, Inc. and five other 'teen' retailers against greater-than-20% declines over the next several months, using optimal puts.


For comparison purposes, I've added the SPDR MidCap Trust ETF (NYSEARCA:MDY) and the Market Vectors Retail ETF (NYSEARCA:RTH) to the table below. First, a reminder about what optimal puts are, and a note about decline thresholds. Then, a screen capture showing the optimal puts to hedge one of the comparison ETFs, MDY.

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% thresholds for all of the names below.

The Optimal Puts for MDY

Below is a screen capture showing the optimal put option contract to hedge 100 shares of the SPDR MidCap Trust ETF MDY against a greater-than-20% drop between now and September 21st. 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 Friday's close

The hedging data in the table below is as of Friday's close, and is presented as percentages of position values. Given the high hedging costs of some of these retail names, 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 might consider buying optimal puts on a sector ETF (such as RTH), or an index-tracking ETF (such as MDY) instead, as a way to hedge your sector or market risk, respectively.



Hedging Cost

AEO American Eagle Outfitters 4.97%*
ANF Abercrombie & Fitch 6.01%*
ARO Aeropostale Inc. 9.97%***
BKE The Buckle, Inc. 5.45%**
GPS The Gap Inc. 5.20%**
ZUMZ Zumiez, Inc. 14.6%*
RTH Market Vectors Retail ETF 3.17%**
MDY SPDR MidCap Trust ETF 2.45%**

*Based on optimal puts expiring in August

**Based on optimal puts expiring in September

***Based on optimal puts expiring in October

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