Workers in Verizon’s Wireless’s National Accessibility Customer Service (NACS) Center. Photo via Verizon.
A Hedged Portfolio Around A Verizon Position
In August of 2018, I wrote about the performance of a bulletproof, or hedged, portfolio built around a position in AT&T (T) in 2017 and presented a new one, which completed in February (each portfolio lasts for six months). Following that, I began presenting hedged portfolios built around other stocks, including Verizon (VZ) in March. Let’s see how our Verizon portfolio finished at the end of six months. First, a reminder of how the portfolio was constructed and what it consisted of.
Constructing The March Verizon Hedged Portfolio
We used the Hedged Portfolio Method to build a concentrated portfolio around VZ in February starting with these premises:
- You had $500,000 to invest.
- You were unwilling to risk a drawdown of more than 12% during the next six months, so you wanted to be hedged against any decline greater than that.
- You wanted to invest in a handful of names, including VZ, with a goal of maximizing your expected total return net of hedging costs.
These were the steps involved for those who wanted to do this manually (your returns would obviously have varied based on which approach you used).
Step 1: Estimate Potential Returns
The goal of this step was to find names that had the potential to generate high total returns to include alongside VZ. My site calculated its own potential returns by analyzing adjusted price history and options market sentiment, but you could have derived yours from Wall Street price targets or the price targets given by Seeking Alpha contributors you follow. Your initial universe could have been as big as my site’s (the ~4,500 stocks and Exchange-Traded Products with options traded on them in the U.S.) or something smaller, such as the Dow 30.
Step 2: Calculate Hedging Costs
Since you were going to hedge, gross potential returns were less important to you than potential returns net of hedging costs. To figure those out, you needed to figure out the optimal or least expensive way to hedge each name. I wrote about how to find optimal hedges here. For this example, you would have been looking for the cost of hedging against declines of 12% or greater. The lower the decline you were looking to hedge against, the narrower the list of names you would have been able to use.
Step 3: Rank Names By Net Potential Return
For each of the names in your initial universe that had a positive potential return, you would have subtracted the hedging cost you calculated in Step 2 to get a net potential return.
Step 4: Buy And Hedge
Here, you would simply have bought and hedged a handful of names that had the highest potential returns net of hedging costs. The automated approach we’ll show below included a fine-tuning step to minimize your cash and another fine-tuning step to decide whether to hedge with puts or collars, but those four steps were the basics.
The March Verizon Hedged Portfolio
Using the process outlined above, this was what our automated hedged portfolio construction tool presented us:
Screen capture via Portfolio Armor
In addition to VZ, the site selected MarketAxess (MKTX), Nexstar Media (NXST), New York Times (NYT), Starbucks (SBUX), and Twilio (TWLO) as primary securities, based on their net potential returns when hedged against >12% declines. The site attempted to allocate roughly equal dollar amounts to each of those names, but rounded down the dollar amounts to make sure it had round lots of each stock.
In its fine-tuning step, it used TWLO again, hedged a different way, to absorb cash left over from the process of rounding down the primary securities. TWLO is hedged in this case with an optimal, or least expensive, collar with a cap set at the current seven-day (annual) yield of the Fidelity Government Cash Reserves money market fund (FDRXX). The hedging cost of this is negative: The idea here is to get a shot at a higher return than cash while lowering the overall hedging cost of the portfolio and limiting your downside risk in accordance with your risk tolerance (to a drawdown of no more than 12%).
Performance Of The Underlying Securities Since
This is how the underlying securities in the hedged portfolio have performed since, unhedged:
Verizon was the third-best performing name here since March 12, up 7.34%. Assuming, for simplicity’s sake, your portfolio was equally weighted and you held each position from March 12 until Thursday’s close, you would have been up 11.85%.
Performance Of The Hedged Portfolio
Here’s how the hedged portfolio performed.
The hedged portfolio was up 8.71%.
Recall the portfolio-level summary at the bottom of this hedged portfolio when I presented it in March:
Screen capture via Portfolio Armor
The expected return was 6%. This portfolio’s actual return was 8.71%, which was in that ballpark. It was also within 9 basis points of the return of the SPDR S&P 500 ETF (SPY), despite taking on less risk than the index ETF, as this portfolio was hedged against a >12% decline. This exemplifies the goal of the hedged portfolio approach: competitive returns with less risk.
Using These Results To Improve The Process
I’ve been presenting hedged portfolios and top names in my Marketplace Service since June of 2017, and I’ve been tracking their performance in real time. I have incorporated that data into my site’s algorithm in ways that should boost performance and improve the accuracy of expected returns. I describe how here: When Strategy Meets Reality.
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.