Dividend Safety And Hedging Costs For 7 Stocks With Yields As High As 19.8%

by: David Pinsen

In a recent article ("7 Dividend Stocks with Yields as High as 19.9%"), Seeking Alpha contributor Sol Palha analyzed a diverse list of dividend-paying stocks, which included a Real Estate Investment Trust (REIT), Master Limited Partnerships, an insurance company, and a few industrial companies. In this post, we'll look at the hedging costs and VectorVest Dividend Safety scores for those seven stocks. 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.

VectorVest ranks Dividend Safety on a scale of 0-99, where 0 is the worst possible score and 99 is the best (scores of 75 and over are considered excellent). 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 homepage, and it will email you the analysis of the stock.

It turned out that three of these seven stocks had Dividend Safety scores greater than 50, which is considered good. Two others had the lowest-possible Dividend Safety score of zero. It was interesting to see that the highest-yielding stock, American Capital Agency Corp. (NASDAQ:AGNC), was also the least expensive of these seven to hedge. In fact, it was only 12 basis points more expensive to hedge than the S&P 500-tracking ETF SPDR S&P 500 Trust (SPY). I've included the updated yields and Dividend Safety scores for all seven stocks in the table below, along with the current costs of hedging them against greater-than-21% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've added the SPDR S&P 500 Trust ETF to the table below. First, a reminder about what optimal puts are, and a note about why I've used 21% as a decline threshold; then, a screen capture showing the optimal puts to hedge the highest-yielding stock listed below, American Capital Agency Corp. (AGNC).

About Optimal Puts

Puts are options that give an investor the right, but not the obligation, to sell a particular security at a specified price (the strike price of the option), on or before a certain date (the expiration date of the option). As such, the puts can offer protection for investors who own a security. 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 often use 20% thresholds when hedging equities, but one of these stocks, Old Republic International Corp. (NYSE:ORI), was too expensive to hedge using a 20% threshold (i.e., the cost of hedging it against a greater-than-20% decline was itself greater than 20%, so Portfolio Armor indicated no optimal contracts were found for it). It was possible to hedge all of the names against greater-than-21% declines, so that's the decline threshold I've used here.

The Optimal Puts for AGNC

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of AGNC against a greater-than-21% drop between now and June 15. 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 (the same is true for the rest of the names below).

(Click chart to expand)

Click to enlarge

Hedging Costs as of Thursday's Close

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



Div. Yield Div. Safety

Hedging Cost

DPM DCP Midstream Partners 5.54% 0 7.58%**
EMR Emerson Electric Co. 3.25% 70 2.74%*
SID Companhia Siderrgica Nacional 8.17% 63 2.88%**
SCCO Southern Copper Corp. 8.38% 51 4.64%*
MWE MarkWest Energy 5.32% 30 5.47%***
AGNC American Capital Agency Corp. 19.8% 32 1.59%*
ORI Old Republic International Corp. 7.57% 0 20.5%**
SPY SPDR S&P 500 2.38% 58 1.47%*
Click to enlarge

*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

***Based on optimal puts expiring in August

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