In a recent article, Seeking Alpha contributor Crunching Numbers wondered whether the market would continue to allow Sirius Satellite Radio (NASDAQ:SIRI) to trade at high free cash flow multiples as the company adds debt. For SIRI investors considering adding downside protection, here are two ways to hedge the stock against greater-than-20% drops from its current price over the next several months.
The first way uses optimal puts*; this way has a cost, but allows uncapped upside. These are the optimal puts, as of Monday's close, for an investor looking to hedge 10,000 shares of SIRI against a greater-than-20% drop between now and June 21:
As you can see in the screen capture above, the cost of those optimal puts, as a percentage of position, is 6.98%. By way of comparison, the current price of the same level of downside protection on large cap tech co. Oracle (NYSE:ORCL) is currently less than 1% of position value.
A SIRI investor interested in hedging against the same, greater-than-20% decline between now and June 21, but also willing to cap his potential upside at 11% over that time frame, could use the optimal collar** below to hedge instead.
As you can see at the bottom of the screen capture above, the net cost of this optimal collar is negative - that means that the SIRI investor would be getting paid to hedge in this case.
*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 stocks and ETFs, scanning for the optimal ones.
**The algorithm to scan for optimal collars was developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University, and is currently available on the web version of Portfolio Armor.
The screen captures above come from the latest build of the soon-to-come 2.0 version of the Portfolio Armor iOS app. Optimal collar capability will be available as an in-app subscription in the 2.0 version of the app.