Hedging 5 A-Plus S&P Earnings And Dividend Stocks

Includes: ETR, JNJ, K, LO, SDY, SYY
by: David Pinsen

Among the challenges in searching for dividend paying stocks is finding ones that exhibit growth and sustainability in their dividend payments. The Earnings and Dividend Ranking system by Standard & Poor's starts with a computerized scoring process to measure growth, stability and cyclicality of earnings and dividends over the most recent 10 year period. S&P then reviews and sometimes modifies those scores to account for special considerations a purely mechanical approach might miss. Then it ranks the stocks according to seven grades, from A-plus to C.

As of Thursday's close, there were approximately 44 optionable stocks with dividend yields over 1% that were ranked A-plus by the Standard & Poor's Earnings and Dividends Ranking system. The table below shows the five highest-yielding of those A-plus stocks, along with the current costs of hedging them against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've added the SPDR S&P Dividend ETF (NYSEARCA:SDY) to the table below. First, a reminder about what optimal puts are, and an explanation of the 20% decline threshold; then, a screen capture showing the optimal puts to hedge one of the names below, Kellogg Company (NYSE:K).

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 all of the names below.

The Optimal Puts for K

Below is a screen capture showing the optimal put option contracts to buy to hedge 100 shares of Kellogg against a greater-than-20% drop between now and September 21st. 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).

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 were taken from Fidelity's screener and 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

Hedging Cost

ETR Entergy 4.98% 2.45%**
LO Lorillard, Inc. 4.73% 3.43%**
SYY Sysco Corp 3.67% 1.02%*
JNJ Johnson & Johnson 3.50% 1.65%***
K Kellogg Co. 3.29% 0.96%**
SDY SPDR S&P Dividend 3.11% 4.19%***
Click to enlarge

*Based on optimal puts expiring in August

**Based on optimal puts expiring in September

***Based on optimal puts expiring in October

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