Hedging 6 VectorVest 'Hidden Gems'

by: David Pinsen

"Hidden Gems" is a screen VectorVest uses to find stocks with lower share prices, above average growth, and above average safety. Specifically, the screen looks for stocks meeting these criteria:

  • Share price under $30
  • 1-3 Year Projected Growth Rate of 20% or higher
  • Relative safety of at least 1.25 (on a scale from 0-2, with 2 being best)

Recall that relative safety is a measure of risk VectorVest calculates based on its analysis of:

The consistency and predictability of a company's financial performance, debt to equity ratio, sales volume, business longevity, price volatility and other factors.

Some of the names that come up in this screen have relatively low trading volumes. The table below shows the six most widely traded stocks that make this screen, along with the costs, as of Wednesday's close, of hedging them against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the cost of hedging the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) against the same decline, using optimal puts. First, a reminder about what optimal puts are, and a note about the decline threshold we're using here. Then, a screen capture showing the optimal puts for our comparison ETF, DIA.

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" is the maximum decline you are willing to risk. 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 the names below.

The Optimal Puts For DIA

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of DIA against a greater-than-20% drop between now and June 15th. A note about these optimal put options and their cost: To be conservative, Portfolio Armor calculated the 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 the ask (the same is true for the other names in the table below).

Hedging Costs As Of Wednesday's Close

The hedging costs below are as of Wednesday's close and are presented as percentages of position values. It's interesting to see high hedging costs for some of these names, despite them all having better than average Relative Safety scores.



Hedging Cost

EMC EMC Corporation 3.21%**
ATVI Activision Blizzard, Inc. 4.20%***
NUAN Nuance Communication 6.85%**
AUY Yamana Gold, Inc. 8.06%**
RES RPC, Inc. 17.4%*
SCSS Select Comfort Corporation 14.0%*
DIA SPDR Dow Jones Industrial Avg. 1.38%*

*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

***Based on optimal puts expiring in August

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in DIA over the next 72 hours.

Additional disclosure: I may purchase optimal puts on DIA in the next few days as a hedge.

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