Hedging 4 Midcaps Trading Near 52-Week Highs
With news out of mega cap Apple, Inc. (AAPL) garnering so much attention this week, some rallying mid caps may have gotten less attention. As of Thursday, though, there were 33 stocks with market caps between $2 billion and $10 billion trading within 1% of their 52-week highs. Given the run these stocks have had, investors who own them may want to consider hedging them against a correction. The table below shows the costs, as of Thursday's close, of hedging four of these rallying mid caps against greater-than-20% declines over the next several months, using optimal puts.
For comparison purposes, I've added the iShares S&P MidCap 400 Index ETF (IJH) and the PowerShares QQQ Trust ETF (QQQ) 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 IJH.
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've used 20% decline thresholds for all of the names here.
The Optimal Puts for IJH
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of IJH against a greater-than-20% drop between now and August 17. 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 of the other names in the table below).
Hedging Costs as of Thursday's Close
The hedging costs below are as of Thursday's close, and are presented as percentages of position values. Note that GNC Holdings Inc. (GNC) is fairly expensive to hedge. If you own it 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 IJH or QQQ) instead, as a way to hedge your market risk.
|GNC||GNC Holdings, Inc.||13.3%**|
|IJH||iShares S&P MidCap 400||1.88%*|
|QQQ||PowerShares QQQ Trust||1.45%**|
*Based on optimal puts expiring in August
**Based on optimal puts expiring in September
***Based on optimal puts expiring in October