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Here's A Way To Get Paid To Hedge Your Facebook Shares

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Shares of Facebook (NASDAQ: FB) are up nearly 100% over the last three months, and are now trading near a 52-week high. For investors looking to add downside protection now, here is a way to get paid to hedge.

Hedging With An Optimal Collar

Below is the optimal collar*, as of Wednesday's close, to hedge 1000 shares of FB against greater-than-14% drop between now and March 21st, for an investor willing to cap his potential upside at 17% over the same time frame. Before we look at it, let me anticipate a question:

Why Would I Want To Cap My Upside At 17% 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 have a big correction over the next several months. On the other hand, you might be willing to cap your upside here in return for getting paid to add downside protection, considering that you're up nearly 100% if you've held this stock through the summer. In that case, here's that optimal collar:

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 $250 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 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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