Two Ways To Hedge Priceline, As It Faces A Growth Threat From Google

Priceline.com Shares Rise But Growth Threat Remains

Shares of Priceline.com, Inc. (Nasdaq: PCLN) rose 1.81% Tuesday as its competitor Expedia (Nasdaq: EXPE) posted a 24% increase in sales. Nevertheless, headwinds remain for both companies. As Kevin Shalvey noted at Investor's Business Daily, Ascendiant Capital Markets senior research analyst Edward Woo has warned about the growth threat posed to Priceline and Expedia by Google (Nasdaq: GOOG), whose acquisition of travel software firm ITA indicated a major move by the search engine giant into travel search and commerce.

The growth threat to Priceline by Google was also mentioned by Morgan Stanley analyst Scott Devitt when he downgraded PCLN recently, as Eric Savitz reported in Forbes last week. Devitt also highlighted the threat PCLN faced from Expedia in Europe.

Adding Downside Protection To Priceline.com

For investors who own Priceline and are considering adding downside protection in light of the growth threat it faces from Google (and from its competitor Expedia), we'll look at a couple of different ways to hedge its shares against a greater-than-20% decline between now and late July.

Why Consider Hedging Against A >20% Drop

A twenty percent decline threshold is worth considering, because it lowers the cost of hedging somewhat (all things equal, the larger the potential loss you are looking to hedge against, the less expensive it is to hedge), and because a 20% decline is not necessarily an insurmountable one. To recover from a 20% loss, an investor would need a 25% rebound in his stock. But to recover from, say, a 35% drop, would require a rebound of nearly 54%.

Two Ways To Hedge PCLN

The first way uses optimal puts*; this way has a higher cost, but allows uncapped upside. These are the optimal puts, as of Friday's close, for an investor looking to hedge 100 shares of PCLN against a greater-than-20% drop between now and July 19th:

As you can see in the screen capture above, the cost of those optimal puts, as a percentage of position, is 2.68%. By way of comparison, the current cost of hedging the SPDR S&P 500 ETF (NYSE: SPY) against the same decline, over the same time frame, is 0.99% of position value.

A PCLN investor interested in hedging against the same, greater-than-20% decline between now and July 19th, but also willing to cap his potential upside at 19% over that time frame, could use the optimal collar** below to hedge instead.

As you can see at the bottom of the screen capture above, the net cost of this optimal collar is negative -- meaning the PCLN investor would be getting paid to hedge in this case.

*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 Ph.D to sort through and analyze all of the available puts for your stocks and ETFs, scanning for the optimal ones.

**The algorithm to scan for optimal collars was developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University, and is currently available on the web version of Portfolio Armor.

The screen captures above come from the latest build of the soon-to-come 2.0 version of the Portfolio Armor iOS app. Optimal collar capability will be available as an in-app subscription in the 2.0 version of the app.