Hedging Recent Analyst Upgrades

Includes: ATI, CASY, EAT, NKE, SPY
by: David Pinsen

According to data compiled by Briefing.com, securities analysts upgraded four stocks last Thursday (versus three stocks that analysts downgraded). Of the four stocks upgraded, one, Nike, Inc. (NKE), was raised from a "Sell" to a "Hold"; the other three stocks -- Allegheny Tech (ATI), Brinker (EAT), and Casey's General Stores, Inc. (CASY) -- were raised from "Hold" to "Buy". Interestingly, though, despite only being upgraded to a "Hold", Nike had the lowest hedging cost of the four stocks that were upgraded. Recall that we've observed examples in the past of stocks with lower hedging costs outperforming stocks with higher hedging costs.

Nike is set to gain a fresh blast of brand exposure at the upcoming Summer Olympics in London. In an article in the Portland Business Journal on Thursday, Erik Siemers reported the release of Nike's new running suits, which will be worn by US track athletes at the summer games. Siemers quoted Nike executive Scott Williams's claim that the company's new Pro TurboSpeed running suits (one of which is modeled by Olympic sprinter Allyson Felix in the photo below, which accompanied Siemers's article) can shave 0.23 seconds off of an athlete's 100-meter dash time (by lowering wind resistance).

For investors in Nike, or one of the other three stocks analysts upgraded on Thursday, who are concerned about limiting downside risk, the table below shows the costs, as of Thursday's close, of hedging all four stocks against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the SPDR S&P 500 ETF (SPY) to the table. Below the table is a reminder about what optimal puts are, and a note about the 20% decline threshold. Then, a screen capture showing the current optimal put to hedge Nike, Inc.

Hedging Costs as of Thursday's Close

The hedging costs in the table below are as of Thursday's close, and are presented as percentages of position values. The name of the firm that employs the analyst who upgraded each company to is listed to the right of the upgraded company's name.

Note that the costs of hedging a few of these stocks are fairly high. If you own these stocks as part of a diversified portfolio, and are content to let that diversification ameliorate your stock-specific risk -- but are still concerned about market risk -- you might consider hedging your market risk by buying optimal puts on an index-tracking ETF such as SPY.



Analyst's Firm

Hedging Cost

ATI Allegheny Tech Deutsche Bank 14.5%***
EAT Brinker Argus 11.1%***
CASY Casey's General Stores, Inc. Feltl & Co. 9.05%*
NKE Nike, Inc. McAdams Wright Ragen 4.40%***
SPY SPDR S&P 500 NA 2.35%**

*Based on optimal puts expiring in November

**Based on optimal puts expiring in December

***Based on optimal puts expiring in January

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 each of the stocks in the table above.

The Optimal Puts To Hedge NKE

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of Nike, Inc. against a greater-than-20% drop between now and January 18th. A note about this optimal put option and its cost: To be conservative, the app calculated the cost based on the ask price of the optimal put. 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 of the other names in the table above).

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