In a recent article ("7 Interesting Plays With Yields As High As 15%"), Seeking Alpha contributor Sol Pahlha analyzed a diverse group of dividend-payers, the highest-yielding of which was Arlington Asset Investment Corporation (AI). AI didn't have any options traded on it, but the other six names did. In this post, we'll look at the VectorVest Dividend Safety scores for all seven names, and the hedging costs for the six that have options traded on them. 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 between 50 and 74 are considered good, and scores of 75 and above 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 four out of these seven names had Dividend Safety rankings in the "good" or "excellent" range. One of those four, Ternium, SA (TX), also had the highest hedging costs of this group, by far. Recall that we've observed examples where high optimal hedging costs presaged poor performance. I've included the updated yields and Dividend Safety scores for all seven names in the table below, along with the current costs of hedging six of them against greater-than-27% declines over the next several months, using optimal puts.
For comparison purposes, I've added the SPDR S&P 500 Trust ETF (SPY) to the table below. First, a reminder about what optimal puts are, and an explanation of the 27% decline threshold; then, a screen capture showing the optimal puts to hedge the comparison one of the names below, Linn Energy, LLC (LINE).
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.
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, but one of these names, Ternium, SA (TX), 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). The lowest decline threshold it was possible to hedge Ternium against was 27%, so that's the decline threshold I've used here.
The Optimal Puts for LINE
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of LINE against a greater-than-27% drop between now and July 20th. A note about these optimal put options and their cost: o 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).
Hedging Costs as of Wednesday's Close
The hedging data in the table below is as of Wednesday's close, and is presented as percentages of position values. The yields and Dividend Safety ratings are as of Wednesday's close as well. Bear in mind that the yields below are annualized, but the hedging costs below aren't.
|Div. Yield||Div. Safety|| |
|LINE||Linn Energy, LLC||7.39%||21||0.94%*|
|AI||Arlington Asset Investment||15.1%||35||No Options Traded On It|
|SPY||SPDR S&P 500||2.33%||58||1.41%***|
*Based on optimal puts expiring in July
**Based on optimal puts expiring in August
***Based on optimal puts expiring in September