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Adding Downside Protection To Advanced Micro Devices

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Advanced Micro Devices (NYSE: AMD) announced its release of a new graphics card before the market open on Tuesday. As of midday Tuesday, traders appeared to be unimpressed, with shares of AMD trading down more than 3%. For AMD investors looking to add downside protection now, here's a way to get paid to do so.

Hedging With An Optimal Collar

Below is the optimal collar*, as of intraday Tuesday, to hedge 1000 shares of AMD against a greater-than-20% drop between today and March 21st, for an investor willing to cap his potential upside at 19% over the same time frame.

As you can see at the bottom of the screen capture below, the net cost of this optimal 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 $60 to do so.

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 JC Penney (NYSE: JCP).

*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 preceding 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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