Micron: "That's A Buy"
On CNBC's "Stop Trading" (video via Seeking Alpha here) on Thursday, Jim Cramer weighed in on Micron Technology (NASDAQ:MU). After acknowledging the boom/bust nature of its industry, Cramer pointed out Micron is in a boom phase and is a likely candidate to be bought out. Referring to Bank of America Merrill Lynch's (NYSE:BAC) upgrade of Micron on Thursday, noted how unusual it was for a Wall Street firm to upgrade a stock all the way from "underperform" to "buy" in one stroke. Cramer's summary on Micron: "That's a buy."
Our site agrees with Cramer and BofA Merrill Lynch. As of Thursday's close, Micron was No. 6 on Portfolio Armor's daily ranking of securities by their potential return over the next six months, net of hedging costs (for an explanation of how it calculates those potential return estimates, see "Calculating A Potential Return For Amazon" here). Coincidentally, the No. 5 stock in that ranking was BAC, which was also one of our top stocks in December.
Our site's potential return for Micron over the next six months was 26%. Those potential returns are high-end estimates: historically, actual returns average 0.3x the potential returns because some of the stocks Portfolio Armor ranks highly end up having negative returns. In the event that happens to Micron, despite Cramer's and Merrill Lynch's bullishness on it, we'll post a couple of hedges for MU below.
Often, we post an optimal put hedge and an optimal collar hedge (for a refresher on hedging terms, see "Refresher on Hedging Terms" here). In this case though, Micron is a little expensive to hedge with puts, so we'll post to collar hedges we found using the Portfolio Armor iOS app (find them without the app by following the steps here). Both of these hedges are for investors who can tolerate a decline of no more than 14% over the next several months. You can, of course, use different parameters when scanning for your own hedges.
Higher Cost, Higher Upside
For this hedge, we used our site's potential return estimate of 26% as the cap.
This was the optimal collar to hedge 1,000 shares of MU against a greater-than-14% drop between now and late July.
As you can see above, the cost of the put leg was $1,510, or 6.18% of position value. But as you can see below, some of that cost was offset by the income generated from selling the call leg: $680, or 2.78% of position value.
So the net cost here was $830, or 3.39% of position value (calculated conservatively, using the ask price of the puts and the bid price of the calls - in practice, you can often buy puts for less and sell calls for more).
Negative Cost, Lower Upside.
For this one, we used a 14% cap to wipe out the positive hedging cost.
This was the optimal collar, as of Thursday's close, to hedge 1,000 shares of MU against a greater-than-14% drop by late July.
In a recursive step, the hedging algorithm was able to use a slightly cheaper put strike due to the lower net cost of the collar. So the cost of the put leg above was $1,160, or 4.74% of position value. The income generated from selling the call leg was a bit higher than that: $1,320, or 5.4% of position value.
So the net cost here was negative, meaning the investor opening this hedge would have collected $160, or 0.65% of position value. Again, this was calculated conservatively, so it's likely he would have collected more than $160.
Taking into account the hedging costs, your maximum upside with the first hedge would be 26% - 3.39% = 22.61%.
And your maximum upside with the second hedge would be 14% - 0.65% = 14.65%.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.