Although the Nasdaq Composite declined 0.24% on Friday, to close at 3,000.45, more Nasdaq names made new highs on Friday than made new lows. There were 63 new 52-week highs on Friday, compared to only 36 new 52-week lows. Sorting the list of new highs by share price, the highest-priced stock was Dollar Tree, Inc. (DLTR). Readers may recall that Dollar Tree was one of the stocks we mentioned last fall that was benefiting from the bifurcation in retail ("Hedging 6 Stocks Benefiting from the Bifurcation in Retail"). The table below shows the current costs of hedging Dollar Tree and four other stocks that made new 52-week highs on Friday, against greater-than-20% declines over the next several months, using optimal puts.
For comparison purposes, I've added 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 put option contract to hedge the comparison ETF, QQQ.
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% decline thresholds for all of the names here.
The Optimal Puts for QQQ
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of the PowerShares QQQ Trust ETF against a greater than 20% drop between now and September 21st. A note about this optimal put option contract and its 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 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 Friday's Close
The hedging costs below are as of Friday's close, and are presented as percentages of position values. Note that Arctic Cat, Inc. (ACAT) 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 QQQ) instead, as a way to hedge your market risk.
|DLTR||Dollar Tree, Inc.||2.76%***|
|ABCO||Advisory Board Co.||5.55%*|
|ACAT||Arctic Cat, Inc.||14.4%*|
PowerShares QQQ Trust
*Based on optimal puts expiring in September.
**Based on optimal puts expiring in October.
***Based on optimal puts expiring in November.
Additional disclosure: I am long optimal puts on QQQ as a hedge against market risk.