Dividend Based ETFs and New Options Listed on the S&P 500 Dividend Index

A new tool for investors and traders will launch this Friday on the CBOE, options on the S&P 500 Dividend Index, ticker symbol DVS. Some may say “So what, is this really a new development?” and when digging deeper, the answer is yes. A number of dividend based ETF strategies are already on the market, and interestingly, none are based on the S&P 500 Dividend Index. Instead, popular products in the dividends space typically track subsets of the S&P 500, or even qualify as “multi-cap” because they may contain not only large cap stocks (i.e. the S&P 500), but also mid and small caps. In short, none of the current dividend based ETFs on the market are created alike.

WisdomTree is one ETF provider that comes to mind in the dividend space, offering a few alternatives here. DLN (WisdomTree Large Cap Dividend) is one, owning 299 individual large cap stocks, and has a yield currently around 3.06%. DTN (WisdomTree Dividend ex-Financials) holds 85 stocks, yields 2.77%, and covers the broad industry sectors excluding financials. Recall that in the market turmoil in 2008, many stalwart financial firms that consistently paid dividends either slashed their dividends, merged with other companies, or in some cases even ceased to continue operations. (Think Bear Stearns, Lehman Brothers, AIG (AIG), Citigroup (C), Morgan Stanley (MS), Merrill Lynch, Bank of America (BAC)).

This brought a sudden dose of irregularity to investors, who were used to steady dividend streams from household names like some of the financials listed above. WisdomTree also runs DTD (WisdomTree Total Dividend Fund) which is a fairly broad based representation of dividend paying stocks. It has over 1,100 holdings in total, and covers stocks listed on the NYSE, Nasdaq, and Amex. The yield here is 3.09%.

Other alternatives in the Dividends ETF space include FVD (First Trust Value Line Dividend Index), yielding 3.10% and SDY (SPDR S&P Dividend ETF) which tracks the S&P High Yield Dividend Aristocrats Index and holds 50 stocks, yielding 3.56%. Also, DVY (iShares Dow Jones Select Dividend Index) yields 3.53% and owns 100 stocks in a Dow Jones based dividend index, while Vanguard also has an entry in the dividend space with VIG (Vanguard Dividend Appreciation ETF), yielding 2.32%. PEY (PowerShares Dividend Achiever 50 Index) yields 3.21% and like DTD, is also a multi-cap strategy.

So there is no shortage of Dividend based ETFs on the market. The trick for an investor is determining which exposure they are looking for. Large cap or Multi-cap? A Dow Jones index, an S&P one, or something else? Are you seeking maximum diversification across hundreds, if not thousands of holdings within one ETF? Or are you comfortable owning 50 stocks within an ETF like PEY? PEY holds stocks that are qualified as dividend payers that have displayed consistent historical growth in dividends. Are you looking for the highest yielding dividend ETF but don’t care that much about maximum diversification or specific sector exposure? Or do you seek an even balance between promising dividend yield and return on principal?

It is possible that a combination of these various dividend ETFs could work in tandem within a portfolio, since as you can see, none of them are created equally, and none track the same index. Now with the availability of options on the S&P 500 Dividend Index, investors can actually hedge out changes in the S&P 500 dividend rate (currently yielding 2%) and/or make speculative calls about the direction of future dividends in the market.

DVS options are expected to be especially popular with market makers traditionally using historical and expected dividends as a major component of their option pricing models. This should equate to reasonably tight bid/ask spreads in the options and healthy volume. The buy and hold investor who likes to own tax efficient ETFs and take in steady dividends as opposed to choosing individual dividend paying stocks, is also greatly reducing security specific risk. As we saw in 2008, just because a company historically paid a dividend, anything can happen and that dividend may not only be slashed sharply but could be halted altogether.

Now, when using Dividend-focused ETFs in their portfolios, these same investors can express their views on the broad market dividend trends through DVS options. They could perhaps add premium income to their portfolios if they are selling calls. (Keep in mind these would be naked positions since DVS does not have a corresponding ETF.) They could also purchase protective puts to cushion any downside that may occur in a broad based dividend slashing environment.

It is also worth noting that of all the ETFs mentioned above, 6 out of 7 of them outperformed the SPY (S&P 500) in the trailing one year period, (see table below) and some very handily. If 2010 shapes up the way the bulls are prognosticating and companies strengthen their balance sheets and financial positions, we could see increases across the board in dividend rates. This would surely create continual interest in not only the dividend focused ETFs but the new DVS options.

Symbol Yield 1 Year Trailing Return

(DTN) 2.77% 76.04%
(FVD) 3.10% 54.21%
(SDY) 3.56% 64.76%
(DVY) 3.53% 58.50%
(VIG) 2.32% 49.09%
(DLN) 3.29% 32.50%
(PEY) 3.21% 42.17%
(SPY) 2.00% 35.57%

The author, Paul Weisbruch, is the VP of ETF/Index Sales/Trading at Street One Financial, an ETF trade execution firm focused on liquidity and helping portfolio managers to navigate through the ever changing universe of ETFs to find the proper ETF product fits for their portfolios. Paul has been quoted in ETF industry publications including Morningstar, Traders Magazine, Index Universe, and TheStreet.com. He holds his Series 4, 6, 7, 55, 63, and 65 licenses.

Written By Paul Weisbruch From Street One Financial

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