According to data compiled by Briefing.com, on Tuesday securities analysts initiated coverage with "outperform" or "overweight" ratings on five stocks. One of those stocks, Greenway Medical (GWAY), did not have options traded on it. The other four newly-rated stocks did have options traded on them. The table below shows the costs of hedging those four optionable stocks against greater-than-20% declines over the next several months, using optimal puts.
For comparison purposes, I've also included the costs of hedging the SPDR Dow Jones Industrial Average ETF (DIA) against the same decline. The costs of hedging some index-tracking ETFs have declined markedly recently, and DIA exemplifies that trend. First, a reminder about what optimal puts are, and a note about the 20% decline threshold. Then, a screen capture showing the current optimal puts to hedge the comparison ETF, DIA.
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" 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 each of the stocks below.
The Optimal Puts For DIA
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of the SPDR Dow Jones Industrial Average ETF against a greater-than-20% drop between now and September 21st. A note about these optimal put options and the 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.
Hedging Costs as of Tuesday's Close
The hedging data in the table below is as of Tuesday's close, and is presented as percentages of position values. The name of the firm that employs the analyst who upgraded each company to "outperform" or "overweight" is listed to the right of the upgraded company's name.
Note that the cost of hedging one of these stocks, Matador Resources (MTDR), was particularly high. Recall that we've observed examples of high optimal hedging costs presaging poor performance. If you own an expensive-to-hedge stock 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 hedging your market risk by buying optimal puts on an index-tracking ETF such as DIA.
|ASML||ASML Holding NV||RBC Capital Markets||6.93%**|
|MTDR||Matador Resources||RBC Capital Markets||18.6%*|
|OIS||Oil States Intl.||Barclays Capital||8.29%*|
*Based on optimal puts expiring in September
**Based on optimal puts expiring in October