Hedging 5 NYSE Stocks Trading At New 52-Week Highs

 |  Includes: AAL, DF, DIA, SHW, WMT
by: David Pinsen

On Thursday, as the NYSE Composite Index advanced fractionally to close at 7,552.36, the number of stocks on the Big Board making new 52-week highs (at 21) slightly outnumbered the number making new 52-week lows (at 18).

One of the stocks on the new high list was US Airways Group, Inc. (LCC). In a recent article, we quoted Bloomberg anchor Adam Johnson on how declining oil prices were bullish for refiners to the extent that they reduce refiners' costs. Lower oil prices, of course, reduce costs for airlines as well, so it wasn't surprising to see US Airways making the list of new highs.

It was a little more surprising to see Wal-Mart Stores, Inc. (NYSE:WMT) on the new high list, given the news last month of the bribery scandal at its Mexican subsidiary. Not only did Dow component Wal-Mart make a new 52-week high on Thursday, but the costs of hedging it were lower than the costs of hedging the Dow itself (via its proxy ETF, SPDR Dow Jones Industrial Average [DIA]). The table below shows the current costs of hedging US Airways, Wal-Mart, and two other stocks that made new 52-week highs on Thursday against greater-than-23% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've added the SPDR Dow Jones Industrial Average ETF to the table. First, a reminder about what optimal puts are, and an explanation of the 23% decline threshold. Then, a screen capture showing the optimal put option contract to hedge Wal-Mart.

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).

Often, I use 20% thresholds when hedging equities, but one of these stocks was too expensive to hedge using a 20% threshold (i.e., the cost of hedging it against a greater-than-20% drop was itself greater than 20%, so Portfolio Armor indicated that no optimal contracts were found for it). There were optimal contracts available for all of these names using a decline threshold of 23%, so that's the threshold I've used below.

The Optimal Puts for WMT

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of Wal-Mart against a greater than 23% drop between now and December 21. 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 Thursday's Close

The hedging costs below are as of Thursday's close, and are presented as percentages of position values. Note that US Airways Group, Inc. is extremely 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 DIA) instead, as a way to hedge your market risk.



Hedging Cost

WMT Wal-Mart Stores, Inc. 1.37%*
SHW The Sherwin-Williams Co. 2.71%*
DF Dean Foods, Inc. 6.97%*
LCC US Airways Group, Inc. 21.0%*




Click to enlarge

*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.