Getting Paid To Hedge Zillow

Getting Paid To Limit Downside On Zillow

Earlier this week, analysts at Pacific Crest Securities recommended investors buy shares of Zillow Z ahead of the company's 3rd quarter earnings call (which is scheduled for November 5th), as they expect Zillow to post strong results. Zillow shares were up more than 125% over the last 52 weeks, as of Tuesday's close: given that the company is currently trading at more than 146 times analysts' forward earnings estimates, Zillow may need to post strong results next month to continue the strong performance of its stock. For Z longs holding big gains, but wary of downside risk going forward, below is a way you can get paid to hedge.

Hedging With A Negative Cost Optimal Collar

Pays you to hedge, 19% upside cap.

If you're willing to cap your potential upside at 19% over the next several months, this was the optimal collar*, as of Tuesday's close, to hedge 1000 shares of Z against a greater-than-18% drop over the same time frame.

As you can see at the bottom of the screen capture above, the net cost of this collar was negative, meaning you would have gotten paid to hedge in this case.

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 optimal collar above would likely have netted more than $500 to do so.

Possibly More Protection Than Promised

In some cases, hedges such as the one above can provide more protection than promised. For a recent example of that, see this post about hedging the iPath S&P 500 Short Term VIX Futures ETN (VXX).

*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. Portfolio Armor's 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.