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Hedge Or Get Off The POT

Jul. 30, 2013 7:03 PM ETNTR
David Pinsen profile picture
David Pinsen's Blog
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Potash Corp. of Saskatchewan (POT) plummeted 16.5% Tuesday as the global potash cartel collapsed. Investors who are still long the stock may want to consider hedging against further declines here are two ways to do so.

1) Hedging With Optimal Puts

Higher cost, but uncapped upside.

These are the optimal puts*, as of Tuesday's close, to hedge 500 shares of POT against a greater-than-16.5% drop between now and January 17th.

As you can see at the bottom of the screen capture below, the cost of this protection, as a percentage of position value, was 4.81%.

2) Hedging With An Optimal Collar

Lower cost, 16.5% upside cap.

If you're willing to cap your potential upside at 16.5% between now and January 17th, this is the optimal collar to hedge 500 shares of POT against a greater-than-16.5% drop over the same time frame.

As you can see at the bottom of the screen capture above, the net cost of this collar, as a percentage of position value, was 0.92%.

If you want to pay even less to hedge, you can use a larger decline threshold, or a lower cap.

Possibly More Protection Than Promised

In some cases, hedges such as the ones above can provide more protection than promised. For a recent example of that, see this post about hedging shares of BlackBerry (BBRY).

*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 PhD to sort through and analyze all of the available puts for your stocks and ETFs, scanning for the optimal ones.

**Optimal collars are the ones that will give you the level of protection you want at the lowest net cost, while not limiting your potential upside by more than you specify. The algorithm to scan for optimal collars was developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University. The screen captures above come from the Portfolio Armor iOS app.

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