Adding Downside Protection To IBM
In a recent article, Arne Alsin laid out a detailed, bearish case against IBM (NYSE:IBM). Here is an inexpensive way investors who decide to remain long IBM can hedge against a significant decline over the next several months.
Hedging IBM Against A >20% Drop
In many of our previous posts on hedging equities, we've used 20% decline thresholds, since 20% is large enough decline that it reduces the cost of hedging, but not so large to be an insurmountable decline to recover from. The screen capture below shows the optimal puts*, as of Tuesday's close, to hedge 100 shares of IBM against a greater-than-20% drop between now and October 18th.
As you can see at the bottom of the screen capture above, the cost of this protection, as a percentage of position value, was 0.84%**. Y.
Possibly More Protection Than Promised
In some cases, hedges such as the ones above can provide more protection than promised. For a recent example of that, see this post about hedging shares of the miner Cliffs Natural Resources (NYSE:CLF).
*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 PhD. to sort through and analyze all of the available puts for your stocks and ETFs, scanning for the optimal ones. The screen captures above are from the Portfolio Armor iOS app.
**Note that, to be conservative, Portfolio Armor calculates hedging 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 ask.