Market Overview

A Shockingly Inexpensive Way To Hedge Taser International

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Taser International (Nasdaq: TASR) shareholders who have owned the stock since August 13th were up a stunning 83% since then, as of Tuesday’s close. For those looking to add some downside protection, we’ll look at couple of different approaches of hedging against a greater-than-20% drop in the stock over the next several months.

Hedging With An Optimal Collar

Below is the optimal collar*, as of Tuesday’s close, to hedge 1000 shares of TASR against a >20% drop between Tuesday, October 1st and March 21st, for an investor willing to cap his potential upside at 19% over the same time frame. Before we look at it, let me anticipate a question:

Why Would I Want To Cap My Upside At 19% For 6 Months?

Well, you might not. In which case, you could pay a lot to hedge, or just take your chances and hope the stock doesn’t suffer a significant correction over the next six months. On the other hand, you might be willing to cap your upside here in return for getting paid to add downside protection, considering your gains since mid-August. In that case, here’s that optimal collar:

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

If you want to add the same level of downside protection without capping your upside, you could hedge with optimal puts instead of an optimal collar, but it will cost you.

Hedging With Optimal Puts

Here is the optimal put, as of Tuesday’s close, to hedge 1000 shares of TASR against a >20% drop:

As you can see at the bottom of the screen capture above, the cost of this protection, as a percentage of position value, was 12.23%. Quite a difference from getting paid to hedge as in the collar example.

Possibly More Protection Than Promised

In some cases, hedges such as the ones above can provide more protection than promised. For a recent example of that, see this post about hedging shares of BlackBerry (BBRY).

*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 Armors 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.

Posted-In: Options Markets Trading Ideas

 

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