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In a Seeking Alpha article on Sunday ("Investing in Dividend Aristocrats, Part I"), Insider Monkey posted a list of dividend-paying stocks that had increased their dividends for at least 25 years. I thought it would be interesting to look at the hedging costs of these stocks. The table below shows the costs, as of Friday's close, of hedging those "Dividend Aristocrats" against greater-than-20% declines over the next several months, using the optimal puts for that.

Comparison

For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) against the same decline. First, a reminder about what optimal puts mean in this context and why I've used 20% as a decline threshold.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. 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 (there's an example of this, with screen-shots, in this recent Seeking Alpha article).

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.

How Costs Are Calculated

To be conservative, Portfolio Armor calculated the costs below based on the ask prices of the optimal put options. In practice, though, an investor may be able to buy some of these put options for less (i.e., at a price between the bid and the ask). Costs are expressed as a percentage of the position value.

Hedging Costs as of Friday's Close

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

Dividend Yield

Hedging Cost

CenturyLink Inc

CTL

7.12%

2.48%**

Cincinnati Financial Corp

CINF

5.44%

2.07%*

Consolidated Edison Inc

ED

4.42%

0.93%**

Abbott Laboratories

ABT

3.44%

1.33%**

Clorox Co

CLX

3.29%

0.73%**

Bemis Co Inc

BMS

2.74%

3.24%**

Coca-Cola Co

KO

2.65%

0.96%**

Automatic Data Processing

ADP

2.58%

1.38%**

AFLAC Inc

AFL

2.49%

3.98%**

Chubb Corp

CB

2.44%

1.93%**

Emerson Electric Co

EMR

2.36%

2.62%**

3M Co

MMM

2.19%

1.50%**

Air Products & Chemicals Inc

APD

2.19%

1.65%*

Exxon Mobil Corp

XOM

2.17%

1.48%**

Archer-Daniels-Midland Co

ADM

2.04%

2.64%**

Becton, Dickinson & Co

BDX

1.78%

1.12%*

Brown-Forman Corp B

BF.B

1.65%

1.32%*

Dover Corp

DOV

1.58%

3.11%*

Cintas Corp

CTAS

1.44%

3.87%***

Ecolab Inc

ECL

1.20%

1.68%**

Bard, C.R. Inc

BCR

0.64%

1.42%**

SPDR S&P 500

SPY

1.73%

1.18%**

*Based on optimal puts expiring in December, 2011

**Based on optimal puts expiring in January, 2012

***Based on optimal puts expiring in February, 2012

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Hedging Costs of Dividend Aristocrats