Seeking Alpha
Portfolio strategy
Profile| Send Message|
( followers)  

Dividend Safety and hedging costs of 'dividend scorchers'

In a Seeking Alpha article published on Tuesday ("Dividend Scorchers with Yields of to 19.9%, Part IV: REITS"), Sol Pahla analyzed 7 high-yielding REITs and suggested that readers considering investing in them do additional due diligence on them. In this post, we'll look at the hedging costs and VectorVest Dividend Safety scores for those REITs. With respect to Dividend Safety, VectorVest defines it as,

An indicator of the assurance that regular cash dividends will be declared and paid at current or at higher rates for the foreseeable future.

To see the VectorVest's Dividend Safety analysis for any dividend-paying stock, you can enter its symbol and your email address on VectorVest's home page, and they will email you their analysis of the stock.

It turned out that one of the 'dividend scorchers' had a Dividend Safety score of 50, which is considered "good" on VectorVest's scale of 0-99 (another one had a Dividend Safety score of 0, which is the worst possible score). I've included the updated yields and Dividend Safety scores for all 7 stocks in the table below, along with the current costs of hedging 5 of them against greater-than-20% declines over the next several months, using optimal puts.

Comparisons

For comparison purposes, I've added the SPDR S&P 500 Trust ETF (SPY), and the Vanguard REIT Index ETF (VNQ). First, a reminder about what optimal puts are, and why I've used 20% as a decline threshold; then, a screen capture showing the optimal puts to hedge one of the 'dividend scorchers' listed below, Hatteras Financial (HTS).

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 HTS

Below (click to enlarge) is a screen capture showing the optimal put option contract to buy to hedge 100 shares of HTS against a greater-than-20% drop between now and May 18, 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 Tuesday's Close

The hedging data in the table below is as of Tuesday's close, and is presented as a percentage of position value. The yields and Dividend Safety ratings are as of Tuesday's close as well. Bear in mind that the yields below are annualized, but the hedging costs below aren't.

Symbol

Name

Div. Yield

Div. Safety

Hedging Cost

(HTS) Hatteras Financial 15.5% 31 4.86%**
(CWH) CommonWealth 11.7% 50 15.5%*
(AGNC) American Capital Agency Corp. 20.0% 32 7.13%***
(ANH) Anworth Mortgage Asset Corp. 14.5% 40 7.90%*
(PCC) PMC Commercial Trust 8.60% 19 No Options Traded on it
(ADC) Agree Reality Corp. 6.54% 27 6.74%*
(MNR) Monmouth Real Estate Investment 7.31% 0 No Optimal Contracts
(VNQ) Vanguard REIT Index 3.51% 58 10.6%***
(SPY) SPDR S&P 500 2.50% 58 4.05%***


*Based on optimal puts expiring in April 2012.

**Based on optimal puts expiring in May 2012.

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



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

Source: Dividend Safety And Hedging Costs For 'Dividend Scorchers' With Yields Up To 20%