4 Mid Caps Rated Buy By Ned Davis Research: A Look At Hedging Them

Includes: CHS, HFC, MNK, SPY, SWY
by: David Pinsen

Analysts at Ned Davis Research employ a quantitative screening process with both fundamental and technical components to rank 1,400 stocks on a scale of 0 (worst) to 100 (BEST). Stocks scoring below 10 are rated "sell," stocks scoring between 10 and 90 are rated "neutral" and stocks scoring above 90 are rated "buy." As of Thursday's close, 17 optionable mid cap stocks with daily trading volumes over 2 million shares were rated "buy" by Ned Davis Research.

One of those 17 stocks, Safeway Inc. (SWY), raised its dividend earlier this week, as The Dynamic Dividend noted on Twitter:

Safeway Raises Dividend for 7th Consecutive Year, Now Yields 3.7%: stks.co/3qMI $SWY

- The Dynamic Dividend (@DynamicDividend) May 15, 2012

Based on Thursday's closing price of $18.40 per share, its dividend yield was slightly higher, 3.8%. The table below shows the costs of hedging Safeway and three other mid caps rated "buy" by Ned Davis against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've added the SPDR S&P 500 ETF (NYSEARCA:SPY) to the table. First, a reminder about what optimal puts are, and an explanation of the 20% 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.

Decline Thresholds

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 each of the names 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-20% decline as of Thursday's close. 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 Thursday's Close

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.



Hedging Cost

SWY Safeway, Inc. 5.98%***
CHS Chico's FAS Inc. 7.44%**

HollyFrontier Corporation



Questcor Pharmaceuticals


SPY SPDR S&P 500 3.01%***

*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.