4 Compelling Dividend Stocks With A Hedging Strategy

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Includes: LO, MO, SO, T
by: Todd Johnson

This article is 100% focused on the dividend investor. Many retirees, part-time workers, and private investors need to receive income, based on the current U.S. Treasury bond sub-1% interest rate market. Investors need to put money to work where returns are greater than 1%. The U.S. Treasury bond market is void of opportunities. The typical investor needs to move out of bonds into a higher-risk asset class: dividend stocks.

Retired investors seeking income are forced to take additional risk to achieve their financial goals. All income-seekers have to reach out to high-yielding bonds or dividend-paying stocks. The Federal Reserve's "Operation Twist" has forced down long-term rates. The recessionary and deflationary pressures have caused Treasury bonds to lack any meaningful purpose in an income-seeking portfolio. As today's Treasury website indicates, all Treasury Bond rates under 5 years offer less than 1% yield:


In this article, I would like to address four popular dividend stocks, and a hedging strategy to reduce the potential for capital loss. Here is the scenario I am trying to avoid:

  • I own 100-shares of XYZ-stock.
  • My purchase price was $30 per share.
  • The annual dividend is $1.50.
  • XYZ pays the $1.50 dividend, but declines from $30 per share to $25 per share.
  • I now have an unrealized $500 loss ($3,000 - $2,500) and receipt of $150 in dividends. The total net loss is $500 - $150 = $350.
Altria Group Inc. (NYSE:MO)
Altria sells cigarettes, smokeless tobacco, and wine. These sales are within the U.S. borders.



In this position, I have taken possession of 100 shares of Altria. I am hedged through January 20, 2012 with a protective put at $24.00 per share. The net debit cost was $5.00. If the stock runs above the $28.00 short call, then I will buy the $28.00 call in and sell a higher-priced Altria call at a later expiration date. In the meantime I have a 6.10% yield vs. the Treasury bond rates of less than 1%.
  • Stock Price: $26.56
  • Annual Dividend: $1.64
  • Dividend Yield: 6.1%
  • Beta: .43
Lorillard, Inc. (NYSE:LO)
Lorillard sells tobacco within the U.S. The company's core brand, Newport, represented over 90% of 2010's revenues.


In this position, I have taken possession of 100 shares of
Lorillard. I am hedged through January 20, 2012 with a protective put at $95.00 per share. The net credit receipt was $30.00. If the stock runs above the $120.00 short call, then I will buy the $120.00 call in and sell a higher-priced Lorillard call at a later expiration date. In the meantime I have a 4.7% yield vs. the Treasury bond rates of less than 1%.
  • Stock Price: $112.95
  • Annual Dividend: $5.20
  • Dividend Yield: 4.7%
  • Beta: .43
AT&T, Inc. (NYSE:T)
AT&T provides global communication services to household and businesses. The company is currently working with the Department of Justice in order to purchase T-Mobile.



In this position, I have taken possession of 100 shares of AT&T. I am hedged through January 20, 2012 with a protective put at $24.00 per share. The net debit cost was $4.00. If the stock runs above the $30.00 short call, then I will buy the $30.00 call in and sell a higher-priced AT&T call at a later expiration date. In the meantime I have a 6.0% yield vs. the Treasury bond rates of less than 1%.
  • Stock Price: $28.16
  • Annual Dividend: $1.72
  • Dividend Yield: 6.0%
  • Beta: .44
Southern Company (NYSE:SO)
Southern provides utility services, primarily in the southeastern region of the United States.



In this position, I have taken possession of 100 shares of Southern. I am hedged through January 20, 2012 with a protective put at $38.00 per share. The net credit receipt was $30.00. If the stock runs above $44.00 short call, then I will buy the $44.00 call in and sell a higher-priced Southern Company call at a later expiration date. In the meantime I have a 4.5% yield vs. the Treasury bond rates of less than 1%.
  • Stock Price: $42.01
  • Annual Dividend: $1.89
  • Dividend Yield: 4.5%
  • Beta: .28

Overall Summary

The article's theme is to avoid equity exposure on any level. The Federal Reserve has forced our hand to move out of bonds. To move into dividend securities, we need to have protection puts in place in order minimize our equity exposure. In order to minimize the cost of the protective puts, we have sold covered calls. In aggregate this option trade is a collar option trade. We still receive our dividends, but our new equity risk has a downside limit. The stocks mentioned have low betas, which is a correlation to the price movement of the stock versus the overall market.

Disclosure: I am long MO, LO, T, SO.