PayPal promotes its P2P service (image via PayPal’s Twitter account).

A Relatively Rare Bearish Take On PayPal

As of this writing, only 2 of 13 Seeking Alpha contributors have given PayPal (PYPL) a bearish rating.

Screen capture via Seeking Alpha.

Contributors’ aggregate bullishness aligns with the bullishness of Seeking Alpha’s Quant Ranting and of the bullishness of Wall Street’s sell side analysts.

One of the two Seeking Alpha PayPal bears, Terracotta Investments, just made a compelling short case for it though, surveying the threats from PayPal’s competition (PayPal: It Only Gets Tougher). Although Terracotta Investments’ price target for PayPal implied an 18% drawdown, my assumption is that most PayPal longs can tolerate a decline of that size. So, what I’ve done here is present a couple of ways cautious PayPal bulls who want to stay long can do so while strictly limiting their risk in the event of a larger decline.

Limiting Your Risk In PayPal

For both of these examples, I am assuming you own 1,000 shares of PYPL and can tolerate a decline of 20% over the time frame of the hedges, but not one larger than that. I’ve done something a little different with these hedges: rather than using the same time to expiration for both, I scanned all available option expirations for PYPL and used the ones with the lowest annualized cost in each case.

Uncapped upside, Positive cost

As of Wednesday’s close, these were the optimal, or least expensive, puts to hedge 1,000 shares of PYPL against a greater-than-20% decline by October 18th.

Optimal Hedge On PayPal via Portfolio Armor.

Screen capture via the Portfolio Armor iPhone app.

The cost of this protection was $20 or 0.02% of position value, calculated conservatively, using the ask price of the puts (in practice, you can often buy and sell options at some price between the bid and ask). That worked out to an annualized cost of 0.91% of position value, which was the lowest annualized cost of any of the option expiration dates for PayPal when hedging against a >20% decline with optimal puts.

Capped Upside, Negative Cost

If you were willing to cap your possible upside at 20% over the time frame of the hedge, this was the optimal collar to protect against the same, >20% decline by next September.

Optimal Hedge On PayPal via Portfolio Armor.

Optimal Hedge On PayPal via Portfolio Armor.

Optimal Hedge On PayPal via Portfolio Armor.

Screen capture via the Portfolio Armor iPhone app.

Here, the cost was negative, meaning you would have collected a net credit of $1,200, or 1.2% of position value, assuming you placed both trades at the worst ends of their respective spreads. That worked out to an annualized cost of -1.27% of position value. That was the lowest (most negative) annualized cost of any of the option expiration dates available for PayPal when hedging with an optimal collar using these parameters.

Wrapping Up: Neutral On PayPal

For readers wondering why I have given PayPal a “neutral” rating here, this is why. Although my site currently estimates a potential return of about 16% for PYPL over the next six months (see the first “w/AHP” column below), that is a bit below the site’s potential return estimate for the SPDR S&P 500 ETF (SPY) over the same time frame.

Screen capture via Portfolio Armor.

Bear in mind, though, that actual returns have averaged approximately 0.28x the site’s potential return estimates, so these should be thought of as high-end estimates.

Transparent And Accountable

To be transparent and accountable, I post the results of all of my top names and hedged portfolios six months after I present them to my Marketplace subscribers. Sometimes there are periods where performance isn’t as good as I’d like. I summarized that performance while writing about it here: The Challenge Of Transparency.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source link