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Downside Protection For T-Mobile US

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Shares of T-Mobile US, Inc. (NYSE: TMUS) closed at $26.05 Friday, after the company priced a secondary offering of 66.15 million shares at $25 per share. This year has been an exciting one so far for TMUS shareholders, given the stock's 30% plunge last May and its subsequent recover. For TMUS investors looking to add some protection against another plunge, in this post, we'll look at a way to add some downside protection.

1) Hedging With Optimal Puts

Uncapped upside, but unavailable in this case.

As of Friday afternoon, it was too expensive to hedge TMUS against a greater-than-15% drop over the next several months with optimal puts* (i.e., taking into account the cost of the put protection, it wasn't possible to limit your losses to no greater than 15%).

Because of that, we were presented with the error message above.

2) Hedging With An Optimal Collar

Pays you to hedge. 15% upside cap.

If you were willing to cap your potential upside at 15% between now and May 16th, this was the optimal collar** to hedge 1000 shares of TMUS against a greater-than-15% 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 negative, meaning you would get paid to hedge.

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 collar above may have gotten paid more than $130 to do so in this case.

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 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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