Sixty-seven stocks beat earnings estimates on Thursday, versus 13 that just met estimates, and 49 others that failed to meet estimates. In this post, we'll look at the hedging costs of five of the stocks that beat estimates Thursday. Of these five stocks, two in particular - Cablevision Systems Corporation (NYSE:CVC) and Fortress Investment Group (NYSE:FIG) - were extremely expensive to hedge. Recall that we have observed examples of high optimal hedging costs presaging poor performance. The table below shows the actual earnings, the consensus estimates and the costs, as of Thursday's close, of hedging these five stocks against greater-than-25% declines over the next several months, using optimal puts.
A Comparison
For comparison purposes, I've also added the costs of hedging the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA). First, a reminder about what optimal puts are, plus an explanation about decline thresholds. Then, a screen capture showing the current optimal puts for 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.
Decline Thresholds
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% thresholds when hedging equities, but two of these stocks were too expensive to hedge using 20% thresholds (i.e., the cost of hedging them against a greater-than-20% drops was itself greater than 20%, so Portfolio Armor indicated that no optimal contracts were found for them). The smallest decline threshold for which there were optimal puts for all these securities was 25%, so that's the threshold I've used for all of the names here.
The Optimal Puts For DIA
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of DIA against a greater-than-25% drop between now and December 21st. A note about this optimal contract and its cost: To be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal put. 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 other names in the table below).
Hedging Costs As Of Thursday's Close
The hedging data below is as of Thursday's close, and is presented as percentages of position values. The "actual" column shows the stocks' actual earnings announced Thursday, and the "estimate" column shows what the consensus estimates were for them.
As we noted above, two of these names have extremely high hedging costs. 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 DIA) instead, as a way to hedge your market risk.
Symbol | Name | Actual | Estimate | Hedging Cost |
CenterPoint Energy, Inc. | $0.34 | $0.33 | 3.30%** | |
CVC | Cablevision Systems Corp. | $0.21 | $0.20 | 22.2%*** |
Teradata Corporation | $0.56 | $0.52 | 1.88%* | |
Denbury Resources | $0.41 | $0.38 | 7.53%*** | |
FIG | Fortress Investment Group | $0.11 | $0.10 | 24.9%*** |
DIA | SPDR DJIA | - | - | 1.18%*** |
*Based on optimal puts expiring in October
**Based on optimal puts expiring in November
***Based on optimal puts expiring in December
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.