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Reminders of the Risk with Single Concentrated Stocks This Week

By Derek Moore

Source: Grubhub Chart Yahoo Finance

In the past week we are once again reminded of the risk inherent in holding un-hedged single concentrated stocks. We know historically non-diversified holdings of a single issue have more than double the expected volatility or standard deviation than the market indexes.

Earnings announcements, pre-announcements, executives leaving the company, regulatory changes, and unforeseen negative news can all quickly cause a sharp reversal in price. Consider the chart of Grubhub above which saw its stock gap down lower by over -43% before recovering mildly. This was after earnings miss and a letter to shareholders that mentioned customers using multiple food delivery services.

Considering the stock hit a high of around $80 in late July, this has retraced over 50% from that point. Now you might say that Grubhub is a newer volatile company and not the best example. I’ll admit while I think I’ve used their service; I have not followed the stock to have an informed opinion.

Fair enough but we only need to look a little further to see another example of price retracing from an established company like McDonalds. While the company had begun a downtrend from its September highs, they announced the departure of their CEO last week.

Source: McDonalds chart Yahoo Finance

Looking at the chart above we can see the stock is down -9.2% from recent levels and close to -15% from its August/September time period.

Single stocks have much more volatility due to them carrying idiosyncratic risk. This is one of two general risk areas for stocks that deals with company specific risks. In theory, this can be diversified away if you hold enough stocks.

Off course the other, systematic market risk, cannot be diversified away but can be hedged as we do with our Buy and Hedge Strategies.   You may find a prospective client that was a former executive at a company, and they hold large quantities of a single stock with very low-cost basis.   That position has huge downside risk, but the good news is that at ZEGA we’ve developed ways to manage that single stock risk. We plan on sharing more of what we’ve been up to shortly so stay tuned.

For now, understand that these types of single stock drawdowns are more common that you might think. So much so that it would have been easy to fill this article with many recent examples. If you are holding large quantities of concentrated stock positions, we should talk to see if we can help.