Crash Protection For Micron

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About: Micron Technology Inc. (MU)
by: David Pinsen
Summary

Six weeks ago, Seeking Alpha contributor Russell Katz warned of a "glaring risk" for Micron, a lawsuit by UMC in China.

Since then, Micron shares are down 19.4%, but, judging by the lack of mention of the lawsuit in UMC's earnings call last week, that may not have been a factor.

For shareholders concerned that the lawsuit or some other factor may drive Micron shares down further over the next several months, I present a couple of ways to hedge it.

Micron steering wheel. Micron making steering wheels complicated (credit: Micron).

Micron: Might There Be More Downside Ahead?

Since Seeking Alpha contributor Russell Katz wrote about Micron's (MU) "glaring risk" (a lawsuit against it in China by United Microelectronics Corp. (UMC)), shares of Micron are down 19.4%.

Chart via YCharts

A search of UMC's Q1 conference call transcript from last week offers no update on this lawsuit, which seems consistent with a comment on that article by "i_am_seeker_2" that UMC's lawsuit is essentially a bluff. Nevertheless, in the event that lawsuit, another idiosyncratic risk, or even a broad market correction drives Micron down further, below are a couple of ways shareholders can stay long while strictly limiting their risk. First, a quick note about Portfolio Armor's current take on Micron.

Not A Top Name Now, But Still Positive

Micron appeared in several Bulletproof Investing portfolios from August 10th of last year to November 22nd, but it hasn't been a top 10 Portfolio Armor name since November 22nd. The site currently estimates a potential return of about 20% for Micron over the next 6 months (historically, actual returns average 0.3x its potential return estimates). Taking into account hedging cost, Micron was #80 on Portfolio Armor's daily ranking as of Tuesday's close. The top 10 names are the ones I present to Bulletproof Investing subscribers on a weekly basis, as those are the ones that have tended to generate strong performance over the next 6 months, as you can see in the table below.

(clicking on a starting date will pull up a chart showing the individual names that week, and their performance).

Starting Date Portfolio Armor 6-Month Performance SPY 6-Month Performance
June 8, 2017 14.49% 9.99%
June 15, 2017 19.85% 10.97%
June 22, 2017 24.46% 11.27%
June 29, 2017 18.24% 11.68%
July 6, 2017 21.03% 14.81%
July 13, 2017 28.25% 14.85%
July 20, 2017 25.04% 14.62%
July 27, 2017 33.52% 17.10%
August 3, 2017 20.72% 12.66%
August 10, 2017 13.05% 8.36%
August 17, 2017 10.71% 13.48%
August 24, 2017 15.23% 13.72%
August 31, 2017 8.42% 10.87%
September 7, 2017 12.75% 11.61%
September 14, 2017 29.19% 11.19%
September 21, 2017 22.56% 9.42%
September 28, 2017 14.30% 4.73%
October 5, 2017 11.53% 5.26%
October 12, 2017 15.46% 5.38%
October 19, 2017 20.73% 6.08%
October 26, 2017 18.10% 5.13%
Average 18.93% 10.63%

The November cohort 22nd cohort that included Micron will be added to that table later this month. Let's look at two ways you can limit your risk in Micron in the meantime.

Adding Downside Protection To Micron

Let's say you're long 1,000 shares of MU and are unwilling to risk a decline of more than 20% over the next several months. Here are two ways of hedging it (screen captures below are via the next version of the Portfolio Armor iPhone app).

Uncapped Upside, Positive Cost

As of Tuesday's close, these were the optimal puts to hedge 1,000 shares of MU against a >20% decline by late October.

Image via MU

As you can see above, the cost here was $2,990, or 6.39%, calculated conservatively, using the ask price of the puts. By the way, the basic version of the Portfolio iPhone app, which allows you to find optimal puts like the one above, is now free to download.

Capped Upside, Negative Cost

If you were willing to cap your upside at 20%, this was the optimal collar to hedge against the same >20% decline over the same time frame.

Image via PA.

There are two things different about this hedge. The first is that, after an iterative process taking into account the collar's net cost, the hedging algorithm was able to find a less expensive put strike, one that lowered the cost of the put leg to $1,760, or 3.76% of position value (calculated conservatively again, using the ask price of the puts). The second is that cost was more than offset by the income of $2,500, or 5.34% of position value, generated from selling the call leg (calculated conservatively, at the bid).

So the net cost was negative, meaning you would have collected a net credit of $740 when opening this hedge, assuming you placed both trades at the worst ends of their respective spreads.

Wrapping Up: A Blow From An Unexpected Quarter

If you agree with i_am_seeker_2 that the UMC lawsuit is a nothing burger, and you don't see any other risks on the horizon for Micron, it can still make sense to consider hedging. Tuesday's price action in IAC/Interactive (IAC) and Match.com (MTCH) offers an instructive example. How many shareholders in those two companies went to bed Monday expecting Facebook (FB) to announce itself as a competitor the next day? The beauty of hedging is that you don't need to know what the blow will be -- whatever drives down the share price, your downside will be strictly limited.

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.