Shares of MasterCard, Inc. (NYSE:MA) hit a 52-week high Friday, but Bob Ciura at Motley Fool warned its valuation was a bit rich at 23 times forward earnings. For investors looking to lock in some gains and add downside protection, here are two ways to hedge.
1) Hedging With Optimal Puts
Higher cost. Uncapped upside.
These were the optimal puts*, as of Monday's close, to hedge 1000 shares of MA against a greater-than-10% drop between now and April 18th.
As you can see at the bottom of the screen capture below, the cost of this protection, as a percentage of position value, was 3.43%.
2) Hedging With An Optimal Collar
Lower cost. 10% upside cap.
If you were willing to cap your potential upside at 10% between now and April 18th, this was the optimal collar** to hedge 1000 shares of MA against a greater-than-10% drop over the same time frame.
As you can see at the bottom of the screen capture above, the net cost of this collar, as a percentage of position value, was 0.63%. Recall that we saw an even larger reduction in cost from hedging with an optimal collar in this post on Celldex Pharmaceuticals (NASDAQ:CLDX) recently.
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 may have paid less than 0.63% to do so.
Possibly More Protection Than Promised
*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.
**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. The 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.