On a good day for tech generally, and on the heels of its announcements yesterday, Zillow (NASDAQ:Z) climbed 7.44% today. Investors who have been long this stock since the beginning of the year are now up over 300%. In this post, we'll look at a way to lock in some of those gains.
Hedging With An Optimal Collar
Below is the optimal collar*, as of Thursday's close, to hedge 1000 shares of Z against a >20% drop between today and February 21st, for an investor willing to cap his potential upside at 15% over the same time frame. Before we look at it, let me anticipate a question:
Why Would I Want To Cap My Upside At 15% For 6 Months?
Well, you might not. In which case, you could pay a lot to hedge, or just take your chances and hope the stock doesn't have a big correction over the next six months. On the other hand, you might be willing to cap your upside here in return for getting paid to add downside protection, considering that you're up over 300% if you've held this stock all year. In that case, here's that optimal collar:
As you can see at the bottom of the screen capture below, the net cost of this optimal collar was negative, meaning you would have gotten paid to hedge in this case.
Note that, to be conservative, Portfolio Armor calculated the cost of this hedge by using the bid price of the call leg and the ask price of the put leg. In practice, you can often sell calls for more (at some price between the bid and ask) and buy puts for less (again, at some price between the bid and ask), so, in actuality, an investor opening the optimal collar above would likely have netted more than $1700 to do so.
Possibly More Protection Than Promised
*Optimal collars are the ones that will give you the level of protection you want at the lowest net cost, while not limiting your potential upside by more than you specify. Portfolio Armor's algorithm to scan for optimal collars was developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University. The screen captures above come from the Portfolio Armor iOS app.