Hedging Update: Social Media Stocks

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Hey fellow Slopers,

Sorry for being scarce recently — I was under the weather for a stretch, but am back in action now.

After seeing Tim's post today on Zynga and Facebook ("Remember to Get Excited About Facebook's IPO"), I thought I'd take another look at the hedging costs of Zynga and a couple of other currently-public social media stocks. First though, a couple of links related to the Zynga and Facebook that might be of interest.

On Monday, the Financial Times published this piece on Zynga founder Mark Pincus and his company's new headquarters ("The Tech World's Willy Wonka"). Judging from Pincus's big smile in the accompanying photo, he doesn't seem to be too troubled by ZNGA's ugly chart.

With respect to Facebook, Bloomberg News tweeted this on Thursday.


According to the link in the tweet above, some institutional investors expressed concerns about the growth of Facebook's advertising revenues relative to its growth of users. After Facebook is public and has options traded on it, it will be interesting to see how expensive it is to hedge. In the meantime, we can look at the costs of hedging a few social media stocks that are public and optionable now. The table below shows the costs, as of Friday's close, of hedging LinkedIN, Zynga, and Pandora against greater-than-27% drops over the next several months, using optimal puts.


For comparison purposes, I've added the Global X Social Media Index ETF (SOCL) and the PowerShares QQQ Trust ETF (QQQ) against the same decline. First, a reminder about what optimal puts are, and a note about why I've used 27% as a decline threshold this time; then, a screen capture showing the optimal put to hedge one of the comparison ETFs, QQQ.

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.

Decline Thresholds

In this context, "threshold" is the maximum decline you are willing to risk. 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).

Often, I use 20% thresholds when hedging equities, but two of these stocks were too expensive to hedge using 20% thresholds (i.e., the cost of hedging them against a greater-than-20% drop was itself greater than 20%, so Portfolio Armor indicated that no optimal contracts were found for them). There were optimal contracts available for all of these names using a decline threshold of 27%, so that's the threshold I've used below.

The optimal put to hedge QQQ against a greater-than-27% drop

Below is a screen capture of the optimal put option contract to buy to hedge 100 shares of QQQ against a greater-than-27% drop between now and December 21st, 2012. A note about this optimal put 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 below).


Hedging costs as of Friday's close

The table below shows the costs of hedging these names against greater-than-27% declines over the next several months. Costs are presented as percentages of position value. Given the high cost of hedging some of these names, if you own them 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 buying optimal puts on an index-tracking ETF (such as SPY) instead, as a way to hedge your market risk. Or you might consider just selling them.



Hedging Cost


Recent Tech IPOs






Pandora Media, Inc.









Global X Social Media Index



PowerShares QQQ Trust


*Based on optimal puts expiring in November

**Based on optimal puts expiring in December