Analysts at Zacks Investment Research use a model-directed fundamental approach to assign "buy," "hold," or "sell" ratings to over 1,100 stocks. Using Fidelity's screener, on Wednesday, I screened for optionable stocks that were rated "buy" by Zacks and also met these two criteria for size and liquidity:
- Market capitalizations between $500 million and $5 billion
- Daily volume of 1 million shares or more traded
I was surprised by the stock that came up at the top of this screen, Green Mountain Coffee Roasters (GMCR), given Green Mountain's major earnings miss last week, and the ouster of its chairman this week, as noted by Seeking Alpha contributor Sam Antar in this tweet Wednesday:
Memo to ousted $GMCR Chairman Stiller: Like u, I used the same margin call excuse to sell my Crazy Eddie stock. We've got a lot in common.- Sam E. Antar (@SamAntar) May 9, 2012
Perhaps Zacks analysts figured that after Green Mountain's recent steep drop in share price (see the chart below), the company is attractive on a valuation basis despite its recent spate of bad news.
In any case, Green Mountain is extremely expensive to hedge now, as the table below shows. That table also lists three other "buy" rated stocks that the screen generated, along with the costs, as of Wednesday afternoon, of hedging them against greater than 25% declines over the next several months, using optimal puts.
For comparison purposes, I've added the SPDR S&P 500 ETF (SPY) to the table. First, a reminder about what optimal puts are, and an explanation of the 25% decline threshold. Then, a screen capture showing the optimal put to hedge the comparison ETF, SPY.
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).
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% drop was itself greater than 20%, so Portfolio Armor indicated that no optimal contracts were found for them). There were optimal contracts available for all of these names using a decline threshold of 25%, so that's the threshold I've used below.
The Optimal Puts to SPY
Below is a screen capture showing the optimal put option contract to hedge 100 shares of the SPDR S&P 500 ETF against a greater than 25% decline as of intraday Wednesday. A note about this optimal put and its cost: To be conservative, the app 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 of the other names in the table below).
Hedging Costs As Of Intraday Wednesday
The hedging costs below are presented as percentages of position value. Given the high cost of hedging some of these names, if you own them 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 an index-tracking ETF (such as SPY) instead, as a way to hedge your market risk.
|GMCR||Green Mountain Coffee||22.9%**|
Tempur Pedic International
|SPY||SPDR S&P 500||1.50%**|
*Based on optimal puts expiring in November
**Based on optimal puts expiring in December