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David Pinsen
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As the founder of Launching Innovation, David Pinsen has brought together a talented team of developers, designers, and academic finance experts to create easy-to-use tools to solve complex problems for investors. David Pinsen brings 17 years of business development, innovation, and financial... More
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  • Hedging Four Stocks With "Very Bullish" Equity Summary Scores 0 comments
    Jul 11, 2012 1:27 AM | about stocks: AGNC, AUY, LLY, LYB, SPY

    Four Stocks With "Very Bullish" Equity Summary Scores

    To aggregate the recommendations of more than ten third party research firms, Fidelity Investments uses Equity Summary Scores, which are calculated by StarMine. StarMine starts with stocks that have been rated by at least four third party research firms; StarMine then uses three steps to rank those stocks:

    1. Normalize. StarMine takes into account the scarcity of ratings at different research firms. For example, if one research gives out relatively few "buy" ratings, a buy rating from that firm will carry more weight in StarMine's meta-analysis than a "buy" rating from research firm that gives out "buy" ratings more frequently.
    2. Weight by research firm accuracy. StarMine looks at the past performance of recommendations by the research firms, so that, for example, a "buy" recommendation by a research firm whose buy recommendations have outperformed significantly carries more weight than a "buy" recommendation by a research firm with less impressive performance.
    3. Calculate. StarMine combines the normalized research firm recommendations with those firms' accuracy weightings to create a single score. Scores range from 0.1 to 10.0, with scores between 9.1 and 10.0 considered to be "very bullish".

    As of Tuesday's close, among stocks with daily trading volumes of 2 million shares or more, the four stocks with the highest Equity Summary Scores were Ely Lilly & Co. (LLY), American Capital Agency Corporation (AGNC), Yamana Gold, Inc. (AUY), and LyondellBasell Industries NV (LYB). Ely Lilly had the highest possible Equity Summary Score: 10. The other three stocks had scores of 9.9.

    A Look At Hedging Those Four Stocks

    For investors in the four stocks mentioned above who are concerned about limiting downside risk, the table below shows the costs, as of Tuesday's close, of hedging those stocks against greater-than-20% declines over the next several months, using optimal puts. Two of those stocks -- Yamana Gold and LyondellBassell Industries -- were fairly expensive to hedge. Recall that we've observed examples in the past of stocks with higher optimal hedging costs underperforming stocks with lower optimal hedging costs.

    A Comparison

    For comparison purposes, I've also added the SPDR S&P 500 ETF (SPY) to the table. Below the table is a reminder about what optimal puts are, and an explanation of the 20% decline threshold. Then, a screen capture showing the current optimal put to hedge the stock with the highest Equity Summary Score, Eli Lilly & Co.

    Hedging Costs as of Tuesday's Close

    The hedging costs in the table below are as of Tuesday's close, and are presented as percentages of position values. As we noted above, the costs of hedging a couple of these stocks were fairly high. If you own these stocks 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 might consider hedging your market risk by buying optimal puts on an index-tracking ETF such as SPY.



    Hedging Cost

    LLY Eli Lilly & Co. 1.10%*
    AGNC American Capital Agency Corp. 2.02%*

    Yamana Gold, Inc.



    LyondellBasell Industries NV


    SPY SPDR S&P 500 1.64%*

    *Based on optimal puts expiring in January

    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). I've used 20% decline thresholds for all of the names in the table above.

    The Optimal Put To Hedge LLY

    Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of the Eli Lilly & Co. against a greater-than-20% drop between now and January 18th. A note about this optimal put option and its cost: To be conservative, the app calculated the cost based on the ask price of the optimal put. 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 above).

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Stocks: AGNC, AUY, LLY, LYB, SPY
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