Slope of Hope Blog Posts

Slope initially began as a blog, so this is where most of the website’s content resides. Here we have tens of thousands of posts dating back over a decade. These are listed in reverse chronological order. Click on any category icon below to see posts tagged with that particular subject, or click on a word in the category cloud on the right side of the screen for more specific choices.

Hedging Update – Stocks

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In order to cover more stocks and ETFs this week, I thought I'd break up the hedging update into two posts — one primarily for stocks, and one for ETFs. The table below shows the costs, as of Tuesday's close, of hedging 10 widely-traded NYSE stocks and 9 of the 10 most widely-traded Nasdaq names against greater-than-20% declines over the next several months, using optimal puts.

Comparisons

For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (SPY) and the SPDR Dow Jones Industrial Average ETF (DIA) against the similar declines. The Nasdaq 100-tracking ETF PowerShares QQQ Trust ETF (QQQ) is also included, as it was on Nasdaq's most active list as of Tuesday. First, a reminder about what optimal puts mean in this context, and why I've used 20% as a decline threshold, plus a note on why there were no optimal puts available for one of the Nasdaq stocks.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web, and as an Apple 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 to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary 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). 

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

How Costs Are Calculated

To be conservative, Portfolio Armor calculated the costs below based on the ask prices of the optimal put options. In practice, though, an investor may be able to buy some of these put options for less (i.e., at a price between the bid and the ask).

Why There Were No Optimal Puts for LVLT

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with Level 3 Communications (LVLT). As of Tuesday, the cost of protecting against greater-than-20% declines in that stock over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for it.

Hedging Costs as of Tuesday's Close

Symbol

Name

Cost of Protection (as % of position value)
  Nasdaq Stocks  
(CSCO) Cisco Systems 5.84%**
(LVLT) Level 3 Communications No optimal puts at this threshold
(MSFT) Microsoft 2.35%**
(INTC) Intel Corporation 3.71%**
(MU) Micron Technologies Inc. 19.3%**
(QQQ) PowerShares QQQ Trust ETF 1.64%*
(ORCL) Oracle 3.02%*
(DELL) Dell, Inc. 4.72%**
(CMCSA) Comcast Corporation 3.34%**
(YHOO) Yahoo! Inc. 7.24%**
(FITB) Fifth Third Bancorp 5.93%**
  NYSE Stocks  
(BAC) Bank of America Corporation 6.94%**
(F) Ford Motor Co. 4.69%*
(S) Sprint Nextel Corp. 9.76%**
(C) Citigroup, Inc. 3.33%*
(PFE) Pfizer, Inc. 1.90%*
(GE) General Electric Co. (GE) 3.01%*
(WFC) Wells Fargo & Company 5.48%**
(NOK) Nokia Corporation 10.70%*
(RF) Regions Financial 12.46%**
(JPM) JPMorgan Chase & Co. 2.69%*

(SPY)

SPDR S&P 500

1.28%*
(DIA) SPDR Dow Jones Industrial Avg. 1.09%*

*Based on optimal puts expiring in December, 2011.

**Based on optimal puts expiring in January, 2012.

Hedging Update (by Dave Pinsen)

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The VIX spiked 18.45% Wednesday, raising hedging costs in many cases. In the table below, I've updated the costs (as of Wednesday'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 other ETFs.

Two new ETF additions this week

This week, I added the Financial Select Sector SPDR (XLF), and iShares MSCI Emerging Markets (EEM). 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.

A note about costs

To be conservative, Portfolio Armor calculates hedging costs using the ask price of the optimal puts. In many cases, you may be able to buy the puts for a lower cost (between the bid and the ask prices).

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

Symbol

Name

Cost of Protection (as % of Position value)

Widely-Traded Stocks

INTC

Intel

3.37%***

CSCO

Cisco Systems

3.30%***

MSFT

Microsoft

3.07%***

LVLT

Level 3 Communications, Inc.

11.4%**

BAC

Bank of America

5.25%***

F

Ford

3.30%**

GE

GE

2.51%**

PFE

Pfizer

2.42%**

SIRI

Sirius XM Radio

No optimal puts: cost exceeds threshold

S

Sprint Nextel

14.9%***

Major Index ETFs

QQQ

PowerShares QQQ Trust

1.48%**

SPY

SPDR S&P 500

1.29%**

DIA

SPDR Dow Jones Industrial Average

1.13%**

Precious Metals ETFs

GLD

SPDR Gold Trust

0.49%**

SLV

iShares Silver Trust

8.35%***

SGOL

ETFS Physical Swiss Gold Shares

2.49%**

SIVR

ETFS Physical Silver Shares

7.27%**
Internet ETF
HHH Merrill Lynch Internet HOLDRs 2.56%*
Other Sector ETFs
XLF Financial Select Sector SPDR 2.53%**
EEM iShares MSCI Emerging Markets 2.86%**

*Based on optimal puts expiring in November, 2011

**Based on optimal puts expiring in December, 2011

***Based on optimal puts expiring in January, 2012

Thank you

The Portfolio Armor iOS app cracked into the top-20 finance iOS apps this week:

App Shopper

Thanks to those of you woul downloaded it.

Follow Up on Speculative Bet (by Dave Pinsen)

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In my post Thursday, I mentioned a few guidelines I've been keeping in mind when making speculative options buys (the first three of which are mentioned in Tim's book, Chart Your Way to Profits):

  • + Start small (since options often expire worthless).
  • + Avoid out-of-the-money-options (instead, try to get ones with some intrinsic value).
  • + Avoid nearby expiration dates (to avoid theta burn and give positions more time to work out).
  • + Buy options at a discount to model estimates of their fair market value.

A Familiar Name

On Thursday night I was going through some screens, and came across a stock I'd already bought puts on a couple of weeks ago — OMER. I had bought the $7.50 strike November puts on it, but it looks like you'd be able to buy the $5 strike November puts on it for a discount to the Black-Scholes estimate of their fair market value today (Friday). More on that below, but first a recap of how I've been looking for these speculative options buys, and a reminder about the difference between speculative options buying and hedging.

Looking for Speculative Options Bets

For the bearish bets, I’ve been starting by scanning for relatively lightly-traded (average daily volume over the last month of < 250k shares), optionable stocks that look weak technically and fundamentally. The idea behind looking for relatively thinly-traded stocks is that the options traded on them are more likely to be thinly-traded, which increases the chances that they might be inefficiently priced. Then I look for in-the-money puts on them several months out, and compare the current bid-ask prices for them with the estimated fair market value of them via the Black-Scholes model.

If I find one where the most recent bid is significantly below the Black-Scholes fair market value estimate, I’ll place a small limit order for it, with the limit price set at a ~20%+ discount to the fair market value estimate.

For the bullish bets, I’ve been doing the reverse: Scanning for stocks that look strong technically and fundamentally, and looking for in-the-money calls priced below the Black-Scholes estimates of their fair market value.

Prior to today, I used this M.O. to purchase puts on JOE, NAK, MOTR, TNDM; and calls on HMC, HIT, COHR, SUP, and ASMI. I noted these purchases (and sales, in the case of HMC, HIT, and MOTR) at the time on the Short Screen message boards.

Hedging vs. Betting

If I were hedging, I would enter the symbol of the stock or ETF I was looking to hedge in the “symbol” field of Portfolio Armor (available as a web app and as an Apple iOS app), enter the number of shares in the “shares owned” field, and then enter the maximum decline I was willing to risk in the “threshold” field. Then Portfolio Armor would use its algorithm to scan for the optimal puts to give me that level of protection at the lowest cost.

On rare occasions (I’ve seen it happen once, so far) the optimal puts Portfolio Armor presents might be in-the-money; in most cases however they will be out-of-the-money. Since I was making a directional bet with OMER, and not hedging, I bought slightly in-the-money options. This makes sense for directional bets (when you are willing to pay more to reduce the odds against your bet) but would be sub-optimal in most cases for hedging (when you want to get a certain level of protection at the lowest possible cost). 

OMER Again

Omeros Corporation (OMER) is a clinical-stage biopharmaceutical company. As I've mentioned before, these are the kinds of stocks I generally prefer to bet against with puts rather than by shorting them, because they can spike on news of an FDA approval, or a partnership deal with a big pharma company.

OMER has a PEG ratio of -0.4 based on analysts' estimates of its (negative, expected) earnings over the next five years.

OMER

I picked up the $7.50 strike November puts on OMER a couple of weeks ago, because OMER was trading above $5 and I wanted to get in-the-money puts (there were no strike prices between $5 and $7.50). OMER closed at $4.69 Thursday though, so the $5 strike puts are now in the money.

As of Thursday's close, the Black-Scholes estimate of the fair market value of the $5 strike, November puts on OMER was $1.73. The bid-ask on them now is $0.90 by $1.25, so even the ask is ~27% below yesterday's B-S fair market value estimate.

Another Speculative Options Bet

By -

In previous posts, I've mentioned a few guidelines I've been keeping in mind when making speculative options buys (the first three of which are mentioned in Tim's book, Chart Your Way to Profits):

  • + Start small (since options often expire worthless).
  • + Avoid out-of-the-money-options (instead, try to get ones with some intrinsic value).
  • + Avoid nearby expiration dates (to avoid theta burn and give positions more time to work out).
  • + Buy options at a discount to model estimates of their fair market value.

I've been making bullish and bearish bets to increase the chances that some bets will make money whatever direction the market takes over the next several months. I've also been trying to take advantage of relatively low volatility when buying options.

On Tuesday night I placed limit orders for a few small bullish and bearish bets. I got a fill on one of the bearish bets Wednesday, puts on BCRX. More on that below. First, a recap of my M.O. here, and a reminder about the difference between speculative options buying and hedging.

Looking for Speculative Options Bets

For the bearish bets, I’ve been starting by scanning for relatively lightly-traded (average daily volume over the last month of < 250k shares), optionable stocks that look weak technically and fundamentally. The idea behind looking for relatively thinly-traded stocks is that the options traded on them are more likely to be thinly-traded, which increases the chances that they might be inefficiently priced. Then I look for in-the-money puts on them several months out, and compare the current bid-ask prices for them with the estimated fair market value of them via the Black-Scholes model.

If I find one where the most recent bid is significantly below the Black-Scholes fair market value estimate, I’ll place a small limit order for it, with the limit price set at a ~20%+ discount to the fair market value estimate.

For the bullish bets, I’ve been doing the reverse: Scanning for stocks that look strong technically and fundamentally, and looking for in-the-money calls priced below the Black-Scholes estimates of their fair market value.

Prior to today, I used this M.O. to purchase puts on JOE, NAK, MOTR, TNDM; and calls on HMC, HIT, COHR, SUP, and ASMI. I noted these purchases (and sales, in the case of HMC, HIT, and MOTR) at the time on the Short Screen message boards.

Hedging vs. Betting

If I were hedging, I would enter the symbol of the stock or ETF I was looking to hedge in the “symbol” field of Portfolio Armor (available as a web app and as an Apple iOS app), enter the number of shares in the “shares owned” field, and then enter the maximum decline I was willing to risk in the “threshold” field. Then Portfolio Armor would use its algorithm to scan for the optimal puts to give me that level of protection at the lowest cost.

On rare occasions (I’ve seen it happen once, so far) the optimal puts Portfolio Armor presents might be in-the-money; in most cases however they will be out-of-the-money. Since I’m making a directional bet in the cases below, though, and not hedging, I bought slightly in-the-money options. This makes sense for directional bets (when you are willing to pay more to reduce the odds against your bet) but would be sub-optimal in most cases for hedging (when you want to get a certain level of protection at the lowest possible cost). If you'd like to read more about hedging, you may want to check out my latest article on it, "How not to insure a stock portfolio".

A Bearish Bet

Biocryst Pharmaceuticals, Inc. (BCRX) is a biotech company that develops small molecule drugs for the treatment of cancer, viral infections, and autoimmune diseases. As I've mentioned before, these are the kinds of stocks I generally prefer to bet against with puts rather than by shorting them, because they can spike on news of an FDA approval, or a partnership deal with a big pharma company.

BCRX

Short Screen shows an Altman Z-Score of 0.86 for BCRX (recall that scores of 1.8 and lower indicate financial distress, according to the model).

I got a fill on a few of the $4 strike December puts on BCRX Wednesday.

Hedging Update (by Dave Pinsen)

By -

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