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Adding Downside Protection To Foster Wheeler

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UPDATE: D.A. Davidson Reiterates On Foster Wheeler AG Following Q3 EPS Report
Foster Wheeler AG Misses Q3 Revenue, Earnings

Shares of Foster Wheeler AG (NASDAQ: FWLT) closed up 6.65% on Thursday, after the company reported strong third quarter numbers. For investors looking to add downside protection now, here are two ways to hedge.

1) Hedging With Optimal Puts

Higher cost. Uncapped upside.

These were the optimal puts*, as of Thursday's close, to hedge 1000 shares of FWLT against a greater-than-20% drop between now and May 16th.

As you can see at the bottom of the screen capture below, the cost of this protection, as a percentage of position value, was 4.30%.

2) Hedging With An Optimal Collar

Lower cost. 20% upside cap.

If you were willing to cap your potential upside at 20% between now and May 16th, this was the optimal collar** to hedge 1000 shares of FWLT against a greater-than-20% drop over the same time frame.

As you can see at the bottom of the screen capture above, the net cost of this collar, as a percentage of position value, was 0.87%.

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 may have paid less than 0.87% 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 Tesla Motors, Inc. (NASDAQ: TSLA).

*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 PhD 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.

Posted-In: Options Markets Trading Ideas

 

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