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David Pinsen
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I founded Launching Innovation, LLC, to bring together developers, designers, and academic finance experts to create easy-to-use tools to solve complex problems for investors.
My company:
Portfolio Armor
My blog:
Steam Catapult
  • Locking In Berkshire Hathaway Gains 2 comments
    Apr 25, 2013 4:34 PM | about stocks: BRK.B, SPY

    Adding Downside Protection To BRK.B

    As Martin Vicek noted in a recent article, Berkshire Hathaway (NYSE:BRK.B) has significantly outperformed S&P 500 year-to-date. Here is an inexpensive way BRK investors can hedge against a significant decline over the next several months.

    Hedging BRK 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 Thursday's close, to hedge 1000 shares of BRK.B against a greater-than-20% drop between now and September 20th.

    As you can see at the bottom of the screen capture above, the cost of this protection, as a percentage of position value, was 0.49%**. By way of comparison, the cost of hedging the SPDR S&P 500 ETF (NYSEARCA:SPY) against the same decline over the same time frame was 0.44%.

    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.

    Stocks: BRK.B, SPY
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Comments (2)
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  • J Mintzmyer
    , contributor
    Comments (3858) | Send Message
     
    Waste of money IMO. Why not just buy SPY puts?
    16 Jun 2013, 06:46 AM Reply Like
  • David Pinsen
    , contributor
    Comments (1065) | Send Message
     
    Author’s reply » Depends what you're looking to hedge. If you want to hedge idiosyncratic risk of owning BRK, you'd by puts on BRK; if you just want to hedge market risk, you could buy SPY puts.
    16 Jun 2013, 12:00 PM Reply Like
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