Internet hedging update
A couple of things stood out when updating the hedging costs for this basket of Internet stocks. Again, it was still too expensive to hedge LinkedIn (LNKD) and Pandora Media, Inc. (P) against greater-than-25% drops over the next several months. Among the stocks for which there were optimal put option contracts available, Netflix (NFLX) was the most expensive to hedge — no surprise, given the awful numbers it released this week; the surprise to me was that there any optimal contracts for it. The table below shows that, as well as the costs, as of Wednesday's close, of hedging several other leading Internet stocks against greater-than-25% declines over the next several months, using optimal puts.
For comparison purposes, I've also added the cost of hedging the PowerShares QQQ Trust ETF (QQQ) against the same decline. First, a reminder about what optimal puts are, and why I've used 25% as a decline threshold here; then, a screen capture showing the optimal puts to hedge one of the stocks listed below, Google, Inc. (GOOG).
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 (available on the web and as an Apple iOS app), 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.
In this context, "threshold" is the maximum decline you are willing to risk in the value of your position. 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). Most of the time, I use 20% thresholds when hedging, for reasons I've mentioned in previous posts, but since I've used 25% thresholds in my previous posts on hedging Internet stocks, I'm doing so here as well.
The optimal puts for GOOG
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of GOOG against a greater-than-25% drop between now and March 16, 2012. A note about these optimal put options and their cost: to be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask.
Why There Were No Optimal Puts for P or LNKD
In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case, as we noted above, with LinkedIn (LNKD) and Pandora Media, Inc. (P). On Wednesday, the cost of protecting against a greater-than-25% decline in both over the next several months was greater than 25%. Because of that, Portfolio Armor indicated that no optimal contracts were found for them.
Hedging costs as of Wednesday's close
Cost of Protection (as % of position value)
|LNKD||No Optimal Contracts|
|P||Pandora Media, Inc.||No Optimal Contracts|
|QQQ||PowerShares QQQ Trust||1.69%*|
*Based on optimal puts expiring in March, 2012
**Based on optimal puts expiring in April, 2012
***Based on optimal puts expiring in May, 2012