Hedging 13 Stocks Exhibiting 'Tech Disconnect'

by: David Pinsen

On Bloomberg TV Friday afternoon, Adam Johnson pointed out an interesting disconnect among tech stocks in the S&P 500: 13 of them were up double digits so far this year, and were trading at P/E multiples of 15 or higher, despite analyst estimates that their Q1 earnings would be down on a year-over-year basis. Adam listed the stocks that met these criteria on his Twitter feed on Friday as well:

Tech Disconnect: Q1 earnings falling YoY yet P/E>15 & Stock>10% $ADI $ALTR $CRM $EA $FLIR $INTU $JDSU $JNPR $LLTC $MOLX $NVLS $TXN$XLNX $$

- Adam Johnson (@AJInsight) March 2, 2012

In this post, we'll take a look at hedging the 13 tech names Adam Johnson identified. The table below shows the costs of hedging them against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've added the SPDR Sector - Technology ETF (NYSEARCA:XLK) to the table below. First, a reminder about what optimal puts are, and a note about decline thresholds. Then, a screen capture showing the optimal puts to hedge the comparison ETF, XLK.

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 have used 20% thresholds for all of the names below.

The Optimal Puts for XLK

Below is a screen capture showing the optimal put option contracts to buy to hedge 100 shares of the tech-tracking ETF XLK against a greater-than-20% drop between now and September 21st. 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 rest of the names below).

Hedging Costs as of Friday's Close

The hedging data in the table below is as of Friday's close, and is presented as percentages of position values.



Hedging Cost

ADI Analog Devices, Inc. 3.62%**
ALTR Altera Corporation 5.38%**
CRM Salesforce.com 6.15%*
EA Electronics Arts Inc. 6.73%**
FLIR FLIR Systems, Inc. 5.84%***
INTU Intuit, Inc. 4.19%***
JDSU JDS Uniphase Corporation 13.8%**
JNPR Juniper Networks, Inc. 9.23%***
LLTC Linear Technology Corp. 2.29%*
MOLX Molex, Inc. 4.12%*
NVLS-OLD Novellus Systems, Inc. 5.14%**
TXN Texas Instruments, Inc. 4.11%***
XLNX Xillinx, Inc. 3.29%**
XLK SPDR Select Sector - Tech 2.37%**

*Based on optimal puts expiring in August

**Based on optimal puts expiring in September

***Based on optimal puts expiring in October

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