Hedging the Most Heavily-Traded Amex Names

The table below shows the costs, as of Friday's close, of hedging the most actively-traded (by dollar volume) American Stock Exchange names against greater-than-20% declines over the next several months, using the optimal puts for that. First, a reminder about why I've used 20% as a decline threshold, and what optimal puts mean in this context, plus a quick note about the American Stock Exchange most actives list.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. With Portfolio Armor (available in Seeking Alpha's Investing Tools Store, and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own, and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary in October 2008:

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

A note about the Amex most actives list

As of Friday, all of the 20 names on the American Stock Exchange's most actively traded list were ETFs, rather than stocks.

Hedging costs as of Friday's close

The data in the table below is as of Friday's close.

Symbol	Name	Cost of Protection (as % of position value)
(SPY)	SPDR S&P 500	1.36%***
(DIA)	SPDR Dow Jones Industrial Avg	1.30%***
(IWM)	PowerShares QQQ Trust	2.14%**
(GLD)	SPDR Gold Trust	0.53%***
(XLE)	Select Sector SPDR -- Energy	2.17%***
(SLV)	iShares Silver Trust	5.08%*
(EFA)	iShares MSCI EAFE Index	1.97%***
(EWZ)	iShares MSCI Brazil Index	2.91%***
(VWO)	Vanguard Emerging Markets	2.48%***
(XLF)	Financial Select Sector SPDR	1.85%***
(OIH)	Oil Services HOLDRs	2.49%*
(XLI)	Industrial Select Sector SPDR	2.04%***
(TNA)	Direxion Daily Small Cap Bull 3X	17.0%*
(TLT)	iShares Barclays 20+ Yr Treas	0.77%***
(SSO)	ProShares Ultra S&P 500	8.92%***
(XOP)	SPDR S&P Oil & Gas Exploration	3.92%***
(IVV)	iShares S&P 500 Index	4.40%***
(FXI)	iShares FTSE China 25 Index	1.86%**
(TZA)	Direxion Daily Small Cap Bear 3X	17.7%*
(XLB)	Materials Select Sector SPDR	2.36%***

*Based on optimal puts expiring in October, 2011.

**Based on optimal puts expiring in November, 2011.

***Based on optimal puts expiring in December, 2011.

Disclosure: I am long some puts on DIA.