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Lower volatility stocks in a higher volatility environment

In a Seeking Alpha article published earlier this month ("Low Volatility, High Yield Stocks to Protect Your Portfolio During a Recession"), G.C. Mays posted a list of low volatility stocks, each yielding over 4% at the time. I thought it would be interesting to look at the hedging costs of those low volatility stocks at a time when broader stock market volatility remains elevated (The VIX S&P 500 Volatility Index rose 8.94% Wednesday, to close at 41.08). The table below shows the current yields for those stocks, as well as the costs, as of Wednesday's close, of hedging them against greater-than-20% declines over the next several months, using optimal puts.

A comparison

For comparison purposes, I've also added the cost of hedging the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) against the same decline. First, a reminder about what optimal puts are, and why I've used 20% as a decline threshold here; then, a screen capture showing the optimal puts to hedge one of the first stock listed below, Entergy Corporation (ETR).

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 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

"Threshold," in this context, is 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. Essentially, 20% is a large enough threshold that it reduces the cost of hedging, but not so large that it precludes a recovery.

The Optimal Puts For ETR

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of against a greater-than-20% drop between now and March, 16, 2012. One 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.


(Click to enlarge)

Hedging costs as of Wednesday's close

The hedging data in the table below is as of Wednesday's close, and is presented as a percentage of position value. The yield data is also as of Wednesday's close.

Dividend Yield

Hedging Cost

Entergy Corporation

(NYSE:ETR)

5.3%

2.58%**

PPL Corporation (PPL) 4.8% 3.49%***
Excelon Corporation (EXC) 4.9% 3.62%***

Public Service Enterprise Grp

(PEG)

4.0%

4.62%**

Spectra Energy (SE) 4.1% 4.47%**
Dominion Resources (D) 3.9% 4.46%***

Altria Group Inc.

(NYSE:MO)

6.2%

3.37%**

Reynolds American Inc.

(NYSE:RAI)

5.7%

2.72%*

Kimberly Clark (KMB) 3.9% 2.72%***
SPDR S&P 500 Trust (SPY)

2.1% 4.19%**

*Based on optimal puts expiring in February, 2012

**Based on optimal puts expiring in March, 2012

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

Source: Hedging A Handful of High Yield, Low Volatility Stocks