Steam Catapult - Launching Innovation

For the most part, I’ve avoided writing about politics on this blog, sharing my opinions instead in 140 character bursts on Twitter. But since tweets seem to be more ephemeral than blog posts, I’m preserving a few salient ones in amber by embedding them below.

This exchange occurred during the second Florida GOP debate last night. Rick Santorum had just snapped at Mitt Romney over the mandate that Romney’s health care law in Massachusetts imposed (state residents either needed to buy health insurance, or pay a fee to help offset the cost of any care hospitals would be obligated to give them if they got sick or injured).

@grivno His essence is competence. Santorum’s is petulance. How do you prevent free riders without mandates?

— David Pinsen (@dpinsen) January 27, 2012

@grivno That doesn’t prevent free riders, because those people will still get free care, by law, when they get sick.

— David Pinsen (@dpinsen) January 27, 2012

@grivno This isn’t Calcutta, we’re not going to let the sick die in the street without treatment. So everyone needs to pay into the system.

— David Pinsen (@dpinsen) January 27, 2012

Since Bill Grivno’s preferred alternative — changing the law so hospitals can deny care to the indigent — is well outside the Overton Window in the US (and probably in every other first world country as well), attacking Mitt Romney for introducing mandates in Massachusetts seems pointless and counterproductive. I can see how it makes tactical sense to use the mandate issue to challenge the Constitutionality of Obama’s health care plan, in order to repeal it because of other, objectionable, aspects of it, but substantively, it’s hard to argue against the logic of a mandate to buy health insurance.

Hedging a High Yield Long Idea

In a post Wednesday morning (“High-Yield Long Idea Idea Continues Strong”), Tim Knight noted the continued strong performance of his long position in the SPDR Barclays High Yield Bond ETF JNK. Back in August, I looked at the cost of hedging JNK, but I thought it might be worth taking another look after seeing Tim’s post. It turns out JNK is pretty inexpensive to hedge right now. The table below shows the cost, as of Wednesday’s close, of hedging it against a greater-than-20% drop over the next several months.

A Comparison

For comparison purposes, I’ve added six of the most actively traded ETFs to the table. First, a reminder about what optimal puts are, and a note about decline thresholds; then, a screen capture showing the optimal puts to hedge JNK.

About Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor (available on the web and as an Apple iOS app) uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

In this context, “threshold” refers to the maximum decline you are willing to risk in the value of your position in a security. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 20% thresholds for each of the securities below.

The Optimal Puts for JNK

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of JNK against a greater-than-20% drop between now and June 15th. A note about these optimal put options and their cost: to be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice, an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask (the same is true of the other names in the table below).

Hedging Costs as of Wednesday’s Close

The data below is as of Wednesday’s close, and is presented as percentages of position values.

*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

***Based on optimal puts expiring in August

Giants Raid San Francisco… Headed to Super Bowl XLVI #nyg twitpic.com/8ajmyj

— New York Post (@NewYorkPost) January 23, 2012

Congrats to NFC champs #Giants! Enter coupon code NFCCHAMPS for a 15% discount on @PortfolioArmor this week: portfolioarmor.com/join-now $$

— Portfolio Armor (@PortfolioArmor) January 23, 2012

The road ahead (The GWB heading toward the mainland. Taken today).

Spook Country

I finished reading William Gibson’s Spook Country this week. Took a while to get into it, but the second half of the book had me hooked. Not a whole lot happens in Spook Country, though, as (spoiler alert) this negative commenter on the Powell’s Books site notes. Something else that commenter mentioned was that Gibson had to write the book due to some contractual obligation. Spook Country isn’t Gibson’s best work, which, in a way, makes his achievement more impressive: Gibson grinding it out is still pretty good.

Anti-Buzz again

The bit about anti-buzz in the book made me think of the press Portfolio Armor got this year (none). I corresponded with and spoke by phone with a reporter at a major business newspaper, who may write about it next year. Or not. I responded to some relevant HARO queries too. Nothing. But that’s cool. I really haven’t played the game well. And I stopped playing altogether a few months ago. I’ve been spending more time working on adding capabilities to PA than hyping it. Looking forward to unveiling some new stuff in 1st Quarter.

Happy New Year.

Seeking Alpha published an article of mine touching on this earlier this week, but the tweet below and the chart that follows it illustrate the tl; dr version. Portfolio Armor was designed to help investors hedge, but other uses for it have emerged. One is as a warning flag for investors in securities with high optimal hedging costs.

I noted that warning for investors in Sears (SHLD) in this tweet on December 18th:

Looks like a red flag for $SHLD longs. MT @portfolioarmor Hedging Bruce Berkowitz stks.co/1avF $AIG $BAC $C $BAM $CIT $BRK.B $JOE

— David Pinsen (@dpinsen) December 18, 2011

And then on Tuesday of this week, SHLD fell out of bed, dropping 27% in one day on news that the company was closing 100+ stores following awful Christmas season sales.

The left side of this chart reminds me of the rock in Close Encounters

Update:

Congrats to NFC champs #Giants! Enter coupon code NFCCHAMPS for a 15% discount on @PortfolioArmor this week: portfolioarmor.com/join-now $$

— Portfolio Armor (@PortfolioArmor) January 23, 2012

From William Gibson’s Spook Country, p. 83 of the G.P. Putnam’s Sons hardcover:

“Tell me about Node, she suggested. “It doesn’t seem to be generating much in the way of industry gossip.”
“No?”
“No.”
He lowered his finger-steeple. “Anti-buzz,” he said. “Definition by absence.”
She waited to see if he’d indicate that he was joking. He didn’t. “That’s ridiculous”.
The smile unshuttered, gleamed, shuttered, and then their drinks arrived, in disposable plastic that protected the hotel against barefoot poolside litigations.

A booth at the Skylark Diner

In a post this fall (“New Features and Things to Come”), I mentioned a few projects that were in the works for Portfolio Armor:

Things to come

A quant on the Portfolio Armor team, a post doctoral fellow at Princeton University, is conducting R&D on the first two features below now. I hope to have them added by the end of this quarter, and the third feature sometime in the first quarter of next year.

• Optimal call options to hedge short positions.
• Optimal collars to hedge long positions, while offsetting the cost of protective puts.
• Dynamic, optimized when-to-sell alerts for call and put options.

All of those features will be as easy to use as the rest of Portfolio Armor, with all the calculations kept in the background, as usual. But if you like math, and you want a sneak peak at the thinking behind the third feature, here’s an excerpt from our Princeton quant’s e-mail about his epiphany about this.

It turned out that our quant ran into a couple of conceptual stumbling blocks while conducting R&D on the second one of those features, optimal collars. After exchanging a series of emails on it, I suggested we meet for lunch at the Skylark Diner, which we did yesterday. Using some non-academic pragmatism, I helped him surmount the conceptual stumbling blocks. He left with a blueprint for how to tackle the problem sketched out over a few legal pad pages.

Meeting in person: still the most effective social medium.