Having Your Cake And Hedging It Too
Another 52-Week High For The Cheesecake Factory
With shares of the upscale, casual restaurant operator The Cheesecake Factory (NASDAQ: CAKE) hitting another 52-week high on Wednesday, here are a couple of ways shareholders can protect their gains with some downside protection.
Two Ways To Hedge CAKE
Below, we'll look at two different ways of hedging CAKE against a greater-than-20% decline. The first way uses optimal puts*; this way has a higher cost, but allows uncapped upside. These are the optimal puts, as of Wednesday's close, for an investor looking to hedge 1000 shares of CAKE against a greater-than-20% drop between now and October 18th:
As you can see in the screen capture above, the cost of those optimal puts, as a percentage of position, is 2.09%. Note that, to be conservative, cost here was calculated using the ask price of the optimal puts; in practice an investor can often buy puts for a lower price (i.e., some price between the bid and the ask).
A CAKE investor interested in hedging against the same, greater-than-20% decline between now and October 18th, but also willing to cap his potential upside at 17% over that time frame, could use the optimal collar** below to hedge instead. We've used a 17% cap here because that was the highest cap at which there was still a significant cost reduction associated with collaring CAKE over the next several months.
As you can see at the bottom of the screen capture above, the net cost of this optimal collar, as a percentage of position value, is 1.05%.
*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.
**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.
The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.