8 Names Yielding Over 9%: A Look At Their Hedging Costs

by: David Pinsen

8 Names Yielding over 9%

In searching for high yielding, optionable securities, I used VectorVest to screen for names that met the following criteria:

  • Dividend yield of 9% or more
  • Dividend safety ranking of 45 or higher (on a scale from 0-99)
  • Buy or Hold recommendation (all except two here are rated "hold")
  • Options traded on them

I found 8 names that met all of those criteria; the two that had a "buy" ratings were NorthStar Realty Finance Corp. (NYSE:NRF) and Dynex Capital Inc. (NYSE:DX). The table below shows the current yields for them, as well as the costs, as of Friday's close, of hedging them against greater-than-20% declines over the next several months, using optimal puts.

One stock I was interested to see appear on this screen was Banco Santander S.A. (STD). I bought puts on it earlier this month, based partly on its inclusion in this Business Insider slideshow of banks most heavily exposed to the European sovereign debt crisis, and based partly on the its high optimal hedging cost at the time. Recall that we've seen high optimal hedging costs presage poor performance on several occasions, most recently in the case of Sears Holdings Corporation (NASDAQ:SHLD), as we noted in a recent article ("A warning Sign That Might Help You Avoid The Next Sears"). As you'll see in the table below, Banco Santander had the highest hedging costs of these 8 names.

A Comparison

For comparison purposes, I've also added the cost of hedging the PowerShares QQQ Trust (QQQ) to the table. 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 stocks we mentioned above, Banco Santander S.A. (STD).

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 STD

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of STD against a greater-than-20% drop between now and June 15, 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.

Click to enlarge

Hedging Costs as of Friday's Close

The hedging data in the table below is as of Friday's close, and is presented as percentages of position values. The yield data is also as of Friday's close. Bear in mind that the yields below are annualized, but the hedging costs below aren't.

Name Symbol

Dividend Yield

Hedging Cost

PennantPark Investment Corp

PNNT 11.1% 10.4%**
CommonWealth REIT

CWH 11.9% 8.71%***
NorthStar Realty Finance Corp. NRF 10.4% 17.8%**
PDL BioPharma, Inc.

PDLI 9.74% 8.06%*
Mesabi Trust MSB 9.63% 15.9%**
Dynex Capital Inc. DX 12.2% 15.3%**
Southern Copper Corp. SCCO 9.35% 8.45%**
Banco Santander S.A. STD 9.44% 20.0%**
PowerShares QQQ Trust QQQ 1.15% 0.81%*
Click to enlarge

*Based on optimal puts expiring in May, 2012

**Based on optimal puts expiring in June, 2012

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

Disclosure: I am long puts on STD.