Defending Your Lockheed Martin Shares

About: Lockheed Martin (LMT)
by: David Pinsen

Seeking Alpha contributor Paul Franke recently offered a bearish case against LMT, arguing it was overpriced, over-leveraged, and facing the possible headwind of declining military spending.

In light of his warning, I present two ways bullish LMT longs can limit their risk while staying long.

I also explain why I'm currently neutral on the stock.

The keel-laying ceremony for Littoral Combat Ship 19 (image via Lockheed Martin tweet.).

Lockheed Martin Stock Price About To Dive?

That was the question Seeking Alpha contributor Paul Franke asked in a recent article about Lockheed Martin (LMT). His answer was, essentially, yes. It's worth reading his article in full, but, in a nutshell, Franke argued that LMT was overpriced, over-leveraged, and facing the possible headwind of declining military spending. Franke also pointed to the stock's poor momentum characteristics (though poor momentum characteristics have been fairly common in this market). If you're long Lockheed Martin, and still bullish on it, but want to limit your risk in the event Paul Franke's warning comes to pass, below, I present a couple of ways of doing that. Remember though: If you're bearish after reading Franke's article, you should sell your LMT shares. Hedging isn't for bears, but for cautious bulls.

Adding Downside Defense For Lockheed Martin

For these two examples, I'm going to assume you have 400 shares of LMT and are willing to tolerate a drawdown of as much as 20% over the next several months, but not one larger than that. The screen captures below are via the Portfolio Armor iPhone app.

Uncapped Upside, Positive Cost

As of Monday's close, these were the optimal or least expensive put options to protect 400 shares of LMT against a greater-than-20% drop by late June.

Optimal put hedge for LMT via Portfolio Armor.

The cost of this protection, as you can see above, was $2,480, or 2.22% of position value. Bear in mind that cost was calculated conservatively, using the ask price of the puts. In practice, you can often buy and sell options at some price between the bid and ask.

Capped Upside, Negative Cost

If you were willing to cap your possible upside at 14% over the same time frame, you could have the optimal collar below to protect against the same, greater-than-20% decline as with the previous hedge.

Optimal collar hedge for LMT via Portfolio Armor. In this case, the put leg uses the same strike as the first hedge, so the cost is the same $2,480, or 2.22% of position value, calculated at the ask. That cost is offset by the income generated from selling the call leg of $2,560, or 2.29% of position value (calculated conservatively, at the bid).

So the net cost of this hedge was negative, meaning you would have collected a net credit of $80 when opening this hedge, assuming you placed both trades at the worst ends of their respective spreads.

Wrapping Up

You may have noticed Seeking Alpha's new policy where contributors indicate whether they are very bullish, bullish, neutral, bearish, or very bearish on a focus stock. I have indicated that I'm neutral on Lockheed Martin, and here I'll explain why. Lockheed Martin passes my site's two screens to avoid bad investments, but it only barely passes the first of those two screens, as you can see in the image below.

LMT Screen from Portfolio Armor

Screen capture via Portfolio Armor.

The first of the two screens is for the mean of the most recent six-month return and the average six-month return over the last 10 years to be positive. That mean figure is shown in the "6m Exp Return" column, and as you can see, it's positive, but fractional. The second screen is that it be possible to hedge the security against a >9% decline over approximately the next six months with an optimal collar. LMT is hedgeable that way - in fact, it's also hedgeable against a >9% decline with optimal puts as well, which is only true of about 20% of the names that pass the first two screens. That said, the site estimates a potential return of less than 1% for LMT over the next six months. Based on that, my sentiment on the stock is neutral.

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.