Hedging Update (by Dave Pinsen)

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In the table below, I've updated the costs (as of Monday's close) of hedging three major index-tracking ETFs against greater-than-20% declines over the several months, using the optimal puts, along with the costs of similarly hedging a handful of their most widely-traded components, and several precious metals ETFs.

Two new ETF additions this week

In the wake of LinkedIn's IPO last week, I also added two Internet ETFs (I suspect when those two ETFs update their top holdings, LinkedIn will be one of them). First, a reminder about why I've used 20% as a decline threshold, and what "optimal puts" means in this context.

Decline thresholds

As I've mentioned before the threshold I usually use when I hedge is 20% (i.e., I want protection against any decline worse than that). The idea for a 20% threshold came from a comment fund manager (and Stanford finance Ph.D.) John Hussman made in October 2008:

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even… a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Optimal puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. With Portfolio Armor (available as a web app, and an iOS app) you just enter the symbol of the stock or ETF you’re looking to hedge, the number of shares you own, and the maximum decline you’re willing to risk, (your threshold). Then the app uses an algorithm developed by a finance Ph.D. candidate to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Costs (as of Monday's close) of hedging against >20% declines

Symbol

Name

Cost of Protection (as % of Position value)

Widely-Traded Stocks

INTC

Intel

1.84%*

CSCO

Cisco Systems

2.02%*

MSFT

Microsoft

1.49%*

LVLT

Level 3 Communications, Inc.

17.5%***

BAC

Bank of America

3.50%**

F

Ford

4.53%***

GE

GE

3.82%***

PFE

Pfizer

2.19%***

SIRI

Sirius XM Radio

10.0%***

S

Sprint Nextel

7.00%**

Major Index ETFs

QQQ

PowerShares QQQ Trust

1.95%***

SPY

SPDR S&P 500

1.63%***

DIA

SPDR Dow Jones Industrial Average

1.39%***

Precious Metals ETFs

GLD

SPDR Gold Trust

0.66%***

SLV

iShares Silver Trust

4.52%*

DBP

PowerShares DB Precious Metals

1.71%*

SGOL

ETFS Physical Swiss Gold Shares

3.25%***

SIVR

ETFS Physical Silver Shares

7.59%***

Internet ETFs
FDN First Trust Dow Jones internet 10.0%*
HHH Merrill Lynch Internet HOLDRs 2.91%**

*Based on optimal puts expiring in October, 2011

**Based on optimal puts expiring in November, 2011

***Based on optimal puts expiring in December, 2011

Twitter

I've noticed other posters here mention that they are on Twitter. In the event anyone's interested in my occasional tweets, here's my Twitter ID (or handle, or whatever it's called): @dpinsen

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