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In a recent article ("8 'Buy' Rated Electric Utilities And Their Hedging Costs"), we looked at the hedging costs of 8 electric utilities that were rated "buy" by VectorVest. In this article, we'll look at 10 gas utilities that were rated "buy" by VectorVest on Friday. Recall that VectorVest uses a quantitative system to assign "buy", "hold", and "sell" rankings to stocks. That quantitative system consists of a weighted average of VectorVest's scores for Relative Safety (NYSE:RS), Relative Timing (NYSE:RT), and Relative Value (RV), with RT overweighted and RV underweighted.

Hedging Costs Of Buy-Rated Gas Utilities

The table below shows costs of hedging these gas utility stocks against greater-than-20% declines over the next several months, using optimal puts. I've also included the costs of hedging the Utilities Select Sector SPDR ETF (NYSEARCA:XLU), for comparison purposes. First, a reminder about what optimal puts are, and why I've used 20% as a decline threshold; then, a screen capture showing the current optimal puts to hedge the comparsion ETF, XLU.

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

In this context, "threshold" refers to 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 XLU

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

Hedging Costs As Of Friday's Close

Aside from the ETF XLU, listed at the bottom for comparison purposes, the utility stocks are listed in order of their 'VST' (Value, Safety, Timing) ranking from VectorVest, with the highest ranked stock EQT Corporation (EQT), listed first.

Symbol

Name

Cost of Protection (as % of position value)

(EQT) EQT Corporation 12.7%*
(NJR) New Jersey Resources 13.9%*
(OKE) ONEOK, Inc. 4.25%**
(SJI) South Jersey Industries, Inc. 3.60%*
(LG) Progress Energy Inc. 3.74%*
(AGL) AGL Resources Inc. 4.37%*
(WGL) WGL Holdings, Inc. 3.52%**
(NI) NISource, Inc. 5.98%**
(VVC) Vectren Corporation 7.43%*
(CNP) CenterPoint Energy, Inc. 11.8%***
(XLU) Utilities Select Sector SPDR 1.59%*

*Based on optimal puts expiring in March 2012.

**Based on optimal puts expiring in April 2012.

***Based on optimal puts expiring in May 2012.

Source: 10 'Buy' Rated Gas Utilities And Their Hedging Costs