Shares of SanDisk (SNDK) hit a 52-week high intraday Wednesday, as the stock was added to the NASDAQ Technology Dividend Index. For those long SanDisk, here are a couple of ways to hedge it over the next several months.
1) Hedging With Optimal Puts
3.8% cost. Uncapped upside.
As of Wednesday’s close, these were the optimal puts* to hedge 1,003 shares of SNDK against a greater-than-20% drop over the next several months with optimal puts.
As you can see at the bottom of the screen capture above, the cost of this protection, as a percentage of position value, was 3.8%.
2) Hedging With An Optimal Collar
0.7% cost. 20% upside cap.
If you were willing to cap your potential upside at 20% between now and October 17th, this was the optimal collar** to hedge 1,003 shares of SNDK against a greater-than-20% 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 0.7%.
Note that, to be conservative, Portfolio Armor calculated the cost of this hedge by using the bid price of the call leg and the ask price of the put leg. In practice, you can often sell calls for more (at some price between the bid and ask) and buy puts for less (again, at some price between the bid and ask), so, in actuality, an investor opening the collar above may paid less than $550, or 0.7% of his position value to do so.
Maximizing Return While Limiting Downside Risk
Optimal puts and optimal collars on securities with high expected returns can be used to build a hedged portfolio around a position, in order to maximize potential return while limiting downside. For an example of a hedged portfolio constructed around another tech stock that hit a new 52-week high this week – Microsoft (MSFT) – see this post.
*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.