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I Own Southern Company And AGL Resources – Now What Do I Do?

Summary The utility stocks Southern Company and AGL Resources are low growth, high yield investments. Southern Company is buying AGL Resources – I own both. What does the transaction mean to shareholders of both companies? This article reviews the transaction as it relates to shareholders going forward. Introduction Utility stocks are generally low-growth high-yield investments. As I will soon illustrate, both Southern Company (NYSE: SO ) and AGL Resources Inc. (NYSE: GAS ) neatly fall into that category. These low growth and above average dividend yield characteristics have led me to only invest in utility stocks when two important conditions are met. First and foremost, when considering utility stocks, I am even more of a stickler for fair valuation. My logic is simple; since long-term historic and future prospects for growth are low, I consider it imperative to only invest when utility stocks can be bought at fair value or below. There is typically not enough growth available to produce an attractive enough total return if you overpay even slightly. With most utilities, the dividends are consistent, but also grow at low rates in conjunction with the utility’s earnings growth. Second, I like to utilize utility stocks when current and dependable income is my primary investment objective. Although many utility stocks can be classified as dividend growth stocks, I tend to like them more for current income than total return. However, when purchased at or below sound valuation, investments in utility stocks can produce acceptable levels of long-term total return. On the other hand, when investing at sound valuations, utility stocks do tend to produce significantly more cumulative dividend income than the average company. As the following two announcements and reports indicate, Southern Company will become the second-largest utility company in the U.S. by customer base after buying AGL Resources. Importantly, Southern Company’s management expects the transaction to accelerate earnings growth in the first full year from its traditional 2% to 3% rate to a higher but still moderate 4% to 5% earnings growth rate. “Southern Co. to buy AGL Resources in $12B deal Aug 24 2015, 07:49 ET | By: Carl Surran , SA News Editor Southern Company (SO) agrees to acquire AGL Resources (GAS) for $66/share in cash, a 38% premium over Friday’s closing price, in a deal with an enterprise value of ~$12B including debt. SO says the deal will create the second-largest utility company in the U.S. by customer base, with 11 regulated electric and natural gas distribution companies providing service to ~9M customers with a projected regulated rate base of ~$50B. SO expects the deal to increase EPS in the first full year after the close and drive long-term EPS growth to 4%-5%” ” MARKET PULSE Southern Co. agrees to buy AGL Resources in $12 billion deal Published: Aug 24, 2015 7:41 a.m. ET By Ciara Linnane CORPORATE NEWS EDITOR Shares of AGL Resources Inc. GAS, +28.52% surged almost 9% in premarket trade Monday, after Southern Co. SO, -3.14% said it has agreed to buy AGL in a deal with an enterprise value of about $12 billion. Southern Co. said it expects the deal to boost earnings per share in the first full year after the close, and to drive long-term EPS growth to 4% to 5%. AGL will become a wholly owned unit of Southern Co., creating the second-biggest utility in the U.S. by customer base. AGL shareholders will receive $66 in cash for each share, a premium of 36.3% over the volume-weighted average stock price over the last 20 trading days through Aug. 21. We believe the addition of AGL Resources to our business will better position Southern Company to play offense in supporting America’s energy future through additional natural gas infrastructure,” Chief Executive Thomas Fanning said in a statement. The deal is expected to close in the second half of 2016. Southern Co. shares were up slightly in premarket trade, but are down 6.7% in the year so far, while the S&P 500 has lost 4.3%.” Here is a link to a report on Reuters that outlines the deal: The Southern Company Purchase of AGL Resources by the Numbers As a shareholder of both Southern Company and AGL Resources, I immediately wanted to know what I might expect from this transaction. In other words, does the deal make economic sense and will it benefit shareholders over the long run? Therefore, I looked at the deal through the lens of the F.A.S.T. Graphs fundamentals analyzer software tool and the FUN Graphs (fundamental underlying numbers) in order to evaluate the value to me as a Southern Company and AGL Resources shareholder. From The Perspective of an AGL Shareholder I was quite content with my position in AGL Resources as I considered the company fairly valued with a blended P/E ratio of 14.3 and I appreciated the 4.3% dividend yield. Additionally, since my cost basis was approximately 39, I was enjoying a reasonable level of capital appreciation coupled with its current above-average yield that had been growing at about 2½% to 3% per annum. The following earnings and price correlated graph illustrates my contentment. (click to enlarge) Of course, the approximate 30% premium over fair value significantly improves the total return I will receive when the transaction is complete. Therefore, from the perspective of an AGL Resources’ shareholder, I am quite pleased with the windfall. The following forecasting calculator on the day of the announcement and based on AGL Resources’ expected midterm future earnings growth illustrates the premium that Southern Company is paying. (click to enlarge) This is what the same graph looks like as of 8/24/2015, which shows the premium price that Southern Company is paying for AGL Resources. This would indicate that technically speaking AGL Resources has become overvalued as a result of the premium paid by Southern Company. (click to enlarge) On the other hand, when looked at from the perspective of expected future cash flows, the premium price that Southern Company is allegedly paying does not look so enticing. Cash flows are expected to increase significantly this fiscal year. Therefore, on the basis of price to cash flow, the apparent premium that Southern Company is paying based on earnings, looks like a bargain based on cash flows. (click to enlarge) When reviewing the cash flow per quarter growth (cflq) that AGL Resources has generated thus far in fiscal 2015, those fiscal year 2015 cash flow projections appear to be on track. So now, I am partially conflicted. I like the premium market valuation, but I’m not so sure that I’m truly receiving a premium price for my AGL shares based on potential cash flow growth. I have circled the last three quarters of cash flow highlighting the cash flow growth over the last three quarters. (click to enlarge) Furthermore, when I evaluate AGL’s historical annual dividends paid per share (dvpps) coverage based on cash flows per share (cflps) I am confident that my dividend was secure. Of course, I am even more confident considering the recent quarterly cash flow growth presented above. (click to enlarge) Furthermore, upon reviewing other valuation ratios, it appears that Southern Company instituted the transaction when AGL’s price to sales (ps) was at reasonable levels. However, the premium price they had to pay is common when a company is purchased outright. (click to enlarge) Additionally, AGL’s price-to-book value (PB) at the time the transaction was initiated was within historical norms as well (the red line). (click to enlarge) The bottom line is that as an AGL shareholder I have mixed views about the transaction. I like the premium market valuation, but I was also content to continue holding my AGL shares for the high yield they were providing. From The Perspective of a Southern Company Shareholder The following long-term earnings and price correlated graph on Southern Company supports my contentment as a shareholder. Although my cost basis in Southern Company was approximately at the same level that the company was trading at prior to the announcement, I was quite happy with my 4.7% dividend yield and believed that the company was fairly valued. Consequently, I was committed to continuing to own this high-quality utility company for many years to come. Moreover, even the approximate 5% price drop as a result of the transaction did not concern me very much because I felt the dividend was secure, above average, and had the potential for a modest amount of future growth. However, I was now faced with the issue of whether my Southern Company investment would continue to make sense after they purchased AGL. (click to enlarge) At this point, I decided that I would give credit to management’s assertion that the transaction would in fact accelerate Southern Company’s future earnings, and therefore, along with it – future dividend growth. Therefore, I reviewed the Forecasting Calculator based on consensus estimates from S&P Capital IQ prior to the AGL transaction. Here I discovered that consensus expected Southern Company’s earnings to grow at a very modest rate of 2.7%. Based on those consensus estimates and assuming that Southern Company would trade at a reasonable P/E ratio of 15 out to fiscal year-end 2018, I came up with a total annual rate of return expectation of 5.22%. Of course, that is nothing to write home about as it only represented capital appreciation of $.85. On the other hand, the $7.70 of projected dividend income was very attractive considering today’s low level of interest rates. Clearly, this is purely an income play and I had no delusions of anything different. (click to enlarge) This is what the expected returns look like after Southern Company’s price drop as a result of the announcement. The announcement brought Southern Company’s stock price into better alignment with fair value. (click to enlarge) For additional insight, I felt the forecasts prior to the transaction announcement were reasonably reliable considering the historical record of analysts forecasting Southern Company’s earnings. As the following analyst scorecard indicates, when making 1-year forward and 2-year forward estimates since calendar year 2000, the record of analysts following Southern Company has been consistently accurate at over 93%. (click to enlarge) Then I ran a similar calculation using the custom Forecasting Calculator based on management’s expectation of earnings growth accelerating to between 4% and 5% as a result of the transaction. I split the difference and ran a calculation based on Southern Company’s 5% drop in price and a forecast 4.5% growth rate. Based on those calculations, I was pleased that my Southern Company investment offered the potential for significantly more capital appreciation of approximately $11.11 versus the $.85 based on growth prior to the transaction. However, I was even more pleased to discover that my dividend income of $13.19 would be close to double what I expected prior to the transaction. Note: all these calculations are made and based on purchasing one share of the stock. The bottom line is that I have concluded that my Southern Company investment holds the potential to be much more attractive after the AGL transaction than it was prior to it. (click to enlarge) As a bonus , I have prepared a free analyze-out-loud video on my website MisterValuation which provides a more in-depth and detailed look at the Southern Company and AGL Resources transaction. Summary and Conclusions From the perspective of a Southern Company shareholder based solely on the numbers, I am enthusiastic and pleased with the AGL transaction. From the perspective of an AGL shareholder, I am disappointed that I will lose the company as a separate holding, but pleased that I will still benefit from its potential as a Southern Company shareholder. Of course, the premium over current market price is also a plus. However, I am now also faced with the challenge of what I will do with the proceeds received from the AGL shares. At this point, I am not yet certain whether I would reinvest the proceeds into Southern Company, or look for another opportunity. However, I have time to assess the situation. Disclosure: Long GAS, SO at the time of writing. Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. Disclosure: I am/we are long GAS,SO. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

The Time To Hedge Is Now – Or Is It Too Late?

Summary Brief overview of the series. Will equities continue falling further on Monday? Things to remember about this strategy and hedging in general. How are we doing so far? Discussion of the risks inherent to this strategy versus not being hedged. Back to August 2015 Update Strategy Overview It is not too late to hedge, but doing it cheaply is getting harder. Most of my positions are working, but not all have shifted into gear yet. I will discuss this aspect of the strategy a little later. But the positions I listed in the August Update have already jumped by an average of 75.7 percent in just three weeks. But this, as series followers know, could be just the beginning. If you are new to this series you will likely find it useful to refer back to the original articles, all of which are listed with links in this instablog . It may be more difficult to follow the logic without reading Parts I, II and IV. In the Part I of this series I provided an overview of a strategy to protect an equity portfolio from heavy losses in a market crash. In Part II, I provided more explanation of how the strategy works and gave the first two candidate companies to choose from as part of a diversified basket using put option contracts. I also provided an explanation of the candidate selection process and an example of how it can help grow both capital and income over the long term. Part III provided a basic tutorial on options. Part IV explained my process for selecting options and Part V explained why I do not use ETFs for hedging. Parts VI through IX primarily provide additional candidates for use in the strategy. Part X explains my rules that guide my exit strategy. All of the above articles include varying views that I consider to be worthy of contemplation regarding possible triggers that could lead to another sizeable market correction. Part II of the December 2014 update explains how I have rolled my positions. I want to make it very clear that I am NOT predicting a market crash. I just like being more cautious at these lofty levels. Bear markets are a part of investing in equities, plain and simple. I like to take some of the pain out of the downside to make it easier to stick to my investing plan: select superior companies that have sustainable advantages, consistently rising dividends and excellent long-term growth prospects. Then I like to hold onto to those investments unless the fundamental reasons for which I bought them in the first place changes. Investing long term works! I just want to reduce the occasional pain inflicted by bear markets. If the market (and your portfolio) drops by 50 percent, you will need to double your assets from the new lower level just to get back to even. I prefer to avoid such pain. If the market drops by 50 percent and I only lose 20 percent (but keep collecting my dividends all the while) I only need a gain of 25 percent to get back to even. That is much easier than a double. Trust me, I have done it both ways and losing less puts me way ahead of the crowd when the dust settles. I may need a little lead to keep up because I refrain from taking on as much risk as most investors do, but avoiding huge losses and patience are the two main keys to long-term successful investing. If you are not investing long term you are trading. And if you are trading, your investing activities, in my humble opinion, are more akin to gambling. I know. That is what I did when I was young. Once I got that urge out of my system I have done much better. I have fewer huge gains, but had also have eliminated the big losses. It makes a really big difference in the end. A note specifically to those who still think that I am trying to “time the market” or who believe that I am throwing money away with this strategy. I am perfectly comfortable to keep spending 1.5 percent of my portfolio per year for five years, if that is what it takes. Over that five year period I will have paid a total insurance premium of as much as 7.5 percent of my portfolio (approximately 1.5 percent per year average, although my true average is less than one percent). If it takes five years beyond the point at which I began, so be it. The concept of insuring my exposure to risk is not a new concept. If I have to spend 7.5 percent over five years in order to avoid a loss of 30 percent or more I am perfectly comfortable with that. I view insurance, like hedging, as a necessary evil to avoid significant financial setbacks. From my point of view, those who do not hedge are trying to time the market. They intend to sell when the market turns but always buy the dips. While buying the dips is a sound strategy, it does not work well when the “dip” evolves into a full blown bear market. At that point the eternal bull finds himself catching the proverbial rain of falling knives as his/her portfolio tanks. Then panic sets in and the typical investor sells after they have already lost 25 percent or more of the value of their portfolio. This is one of the primary reasons why the typical retail investor underperforms the index. He/she is always trying to time the market. I, too, buy quality stocks on the dips, but I hold for the long term and hedge against disaster with my inexpensive hedging strategy. I do not pretend that mine is the only hedging strategy that will work, but offer it up as one way to take some of the worry out of investing. If you do not choose to use my strategy that is fine, but please find a system to protect your holdings that you like and deploy it soon. I hope that this explanation helps clarify the difference between timing the market and a long-term, buy-and-hold position with a hedging strategy appropriately used only at the high end of a near-record bull market. Will equities continue falling further on Monday? This is the $64 million question, is it not? Consider this: the three major indexes all closed at the daily lows. Momentum appears to be to the downside if there is any carry over from the panic selling on Friday. Volume was also the heaviest near the close. I did a little analysis of how many stocks fell how much for both the S&P 500 (NYSEARCA: SPY ) and Dow Jones Industrials (NYSEARCA: DIA ) and the results were interesting. In the Dow there were 22 of the 30 component companies down more than 10 percent; 14 down more than 15 percent; and 10 down more than 20 percent. For the S&P 500 the results were also quite dramatic: 348 down by more than 10 percent; 236 down more than 15 percent; and 153 down by more than 20 percent. This was after just four down days! Oh, and the market breadth, as can be expected, was horrible with zero new 52-week highs and 627 new 52-week lows on the NYSE. Of course, that is not an indicator; but it is an ominous result. Why did investors all head for the doors at the same time? Many investors have accumulated huge gains in a relatively small number of stocks. The momentum was favorable for a long time and it just kept churning higher without apparent regard to valuation. Several issues got way ahead of where they belonged based upon respective future prospects. Investors were willing to pay as much as double what they should have been willing to pay for expected levels of growth. What was the catalyst that started the slide? I think that concerns over global demand have finally caught the eye of Wall Street. China is not growing at anywhere near the seven percent rate officially reported. Chinese officials claim that domestic consumption is growing at a ten percent pace this year. If imports are down and manufacturing output is down, then what are those consumers buying? Domestic consumption is one of the key inputs into GDP growth calculations and it is the one piece of the pie that external observers cannot find a proxy with which to measure it. Shipping tonnage into the country tells us much about imports. Exports are measured by all the receiving nations. Manufacturing is measured using the Purchasing Managers Index, which has stubbornly remained in contraction territory. Retail sales and services data are all collected and reported by the Chinese government. It is the one thing government controls and can manipulate. I just do not see how consumption can grow ten percent when there is no concurrent growth in imports or manufacturing. The other concern is how low will the price of oil go and what impact will it have on the energy industry? I have written extensively on this recently in my “Energy Sector Outlook” series and other articles, the links to which can be found here . The price of WTI crude dipped under $40 on Friday but bounced back above that crucial psychological level. Will it hold? Maybe for a few days or weeks, but not for much longer, in my opinion. This video from Bloomberg expresses why I think the price for oil can go lower into fall. Finally, I want to include a link to the recent letter to clients from John Hussman. I know he has been crying wolf for a long time and many have ridiculed his diatribes about how the market will fall. In his defense, many of the most reliable indicators that have foretold previous corrections and bear markets have not worked in the current environment of artificially low interest rates and quantitative easing which have stimulated asset valuations to soar and profit margins to reach peak levels artificially. I say artificially because if interest rates were to be normalized margins would be much lower (cost of money would be higher reducing profits) and asset prices would also be much lower. He has been on the wrong side until now. But the one chart he uses from Bank of America Merrill Lynch about half way down the letter is very compelling. It shows client net buys by client type for the last week and four weeks. The only client type that is net positive in buying is corporations buying back shares. All others (Institutions, Hedge Funds and Private Clients) have all been net sellers. So, corporation have been propping up share prices and now that type of buying is likely going to dry up, too. Something to think about. In a nutshell, if equities on the Shanghai exchange continue to fall in the face of government intervention and if the price of oil cannot hold above $40 on Monday, I believe our equity markets will likely have further to fall. To go a little further, I believe that as long as those two situations continue to be negative the outlook for global equity markets will also remain negative. I am keeping my eye on those two tells to help me determine when the worst is over. You might want to do the same. Things to remember about this strategy and hedging in general First thing to remember is that this strategy is not designed to work aggressively until the broad market indices are down by 15 percent. Then the gains should really start to kick in. The second thing to remember is that these candidates will underperform the market during a recessionary period. If the equities market corrects without the U.S. economy falling into a recession, then the potential gains for these candidates will not be as great. I am protecting myself against a “major” downturn in stocks, not against a mild correction. I am still invested for the long term, so I am not hoping for a crash, but I am also not putting my head in the sand and ignoring that the potential for equities to go much lower is real. When the S&P 500 index get to a negative 15 percent from its May high, assuming we are entering a recession, this strategy will suddenly begin to kick into high gear as equities fall further. It is between a drop of 15 percent and 30 percent where most of the gains will be acquired by the positions listed in previous installments of this series. If the market firms without reaching that level and turns higher, I may be faced with yet another year of rolling our positions to situate my portfolio for what comes next. I do not give up on my strategy as it will pay off in the end. Until then, it is just insurance against a collapse. If no collapse comes (highly doubtful that central banks have finally figured out how to prevent recessions forever) I will have given up less than one percent of my portfolio per year for the peace of mind in knowing that I am covered just in case. How are we doing so far? The answer depends upon when we bought our puts and at which strikes. Overall, each set of options listed in each article are in positive territory when taken as distinct groups. Individually, some are still worth very little. I own some of both, big winners and losers. Below I list the options I have listed in previous articles since April 2015, all of which expire in January 2016. Stock Symbol Strike Price Premium Paid Premium Available Gain / Loss % Gain / Loss GT $15 .50 .10 – .40 – 80% GT $18 .55 .15 – .40 – 73% GT $20 .50 .20 – .30 – 60% GT $25 .70 .90 + 20 + 29% GT $22 .30 .35 + .05 + 17% BID $30 .50 .85 + .85 + 70% BID $35 .90 2.25 +1.35 +150% BID $31 .55 1.10 +.55 100% ETFC $15 .42 .10 – .32 -76% ETFC $17 .55 .29 – .26 -47% ETFC $20 .69 .60 – .09 -13% ETFC $25 .84 1.95 +1.11 +132% ETFC $22 .43 .78 +.35 + 81% KMX $35 .95 .10 – .85 – 90% KMX $35 .65 .10 – .55 – 85% KMX $40 1.15 .25 – .90 – 78% KMX $40 .90 .25 – .75 – 72% KMX $55 1.85 2.65 +.80 +43% KMX $55 1.40 2.65 +1.25 + 89% KMX $57.50 1.80 3.70 +1.90 +106% JBL $15 .25 .30 +.05 + 20% JBL $18 .40 .95 +.55 +138% JBL $15 .20 .30 +.10 + 50% LB $40 .50 .05 – .45 – 90% LB $50 1.00 .15 – .85 – 85% LB $56.50 1.25 .45 – .80 – 64% LB $56.50 .95 .45 – .50 – 53% LB $65.50 1.10 1.15 +.05 + 5% LB $70.50 1.85 1.95 +.10 + 5% LB $72 1.45 2.30 +.85 + 59% LB $70.50 1.50 1.95 +.45 + 30% MAR $50 1.25 .40 – .85 – 68% MAR $50 .65 .40 – .25 -39% MAR $55 .80 .60 – .20 – 25% MAR $50 .55 .40 – .15 – 27% MAR $65 1.75 2.80 +1.05 + 60% MAR $62.50 1.45 2.05 +.60 + 41% LVLT $40 1.10 .90 – .20 – 18% LVLT $42 .90 1.55 +.65 + 72% MS $25 .76 .31 -.45 – 59% MS $25 .28 .31 +.03 + 11% MS $28 .44 .61 +.17 + 39% MS $34 .92 2.29 +1.37 +149% MS $35 .96 2.80 +1.84 +192% MU $17 .60 3.55 +2.95 +492% MU $17 .40 3.55 +3.15 +788% MU $20 .49 5.90 +5.41 +1104% MU $18 .33 4.30 +4.97 +1203% MU $15 .47 2.28 +1.81 +385% MW $45 .75 .90 +.15 +20% RCL $42 1.26 .08 -1.18 – 94% RCL $50 1.22 .22 -1.00 – 82% RCL $45 .78 .12 – .66 – 85% RCL $47 .67 .15 – .52 – 78% RCL 62.50 1.45 .86 – .59 – 41% RCL 72.50 1.65 2.26 +.61 + 7% STX $40 .48 1.25 +.77 +160% STX $38 .58 .91 +.33 + 7% STX $35 .43 .55 +.12 + 8% STX $35 .52 .55 +.03 + 6% TPX $35 2.10 .05 -2.05 – 98% TPX $35 .75 .05 – .70 – 93% TPX $50 1.45 .30 -1.15 – 79% TPX $60 1.50 1.05 – .45 – 30% UAL $28 .87 .10 – .77 – 89% UAL $35 1.26 .35 – .91 – 72% UAL $37 .92 .55 – .37 – 40% UAL $32 .62 .09 – .53 – 85% UAL $37 .81 .55 – .26 – 32% VECO $20 .45 1.05 +.60 +133% VECO $20 .40 1.05 +.65 +163% WSM $55 1.90 .15 -1.75 – 92% WSM $55 1.60 .15 -1.45 – 91% WSM $60 1.65 .35 -1.30 – 79% WSM $60 1.85 .35 -1.50 – 81% WSM $60 1.25 .35 – .90 – 72% WSM $70 1.90 1.35 – .55 – 29% WSM $72.50 1.80 2.00 +.20 + 11% Some positions are already doing well, most notably Micron Technology (NASDAQ: MU ). I decided to do an account at this time because I will may not many more recommended positions for now. It seems to me that we could either have the market go down further, in which case new positions would be very expensive; or we may not have another good entry point (new market highs) before year end at which time I would begin to roll my positions to expirations further into the future. Finally, I can imagine what some readers are thinking: there are a lot of those options that are still deep in the hole. I have not given up on those positions either. If the U.S. economy enters a recession I remain confident that those stocks will fall a long way from current levels and provide decent protection. Of course, some will do better than others. Hang in there. There may be much further down to go! One final note: if enough readers request in the comments section that I list my favorite options yet again, I will follow up as quickly as I can with what I would do now if I were not fully protected. I will do a follow up article with new recommendations only if there are more than five comments from more than five individuals requesting that I do so. There are still some good options out there, but we really need to be selective now and it will cost a bit more. Brief Discussion of Risks If an investor decides to employ this hedge strategy, each individual needs to do some additional due diligence to identify which candidates they wish to use and which contracts are best suited for their respective risk tolerance. I do not always choose the option contract with the highest possible gain or the lowest cost. I should also point out that in many cases I will own several different contracts with different strikes on one company. I do so because as the strike rises the hedge kicks in sooner, but I buy a mix to keep the overall cost down. My goal is to commit approximately two percent (but up to three percent, if necessary) of my portfolio value to this hedge per year. If we need to roll positions before expiration there will be additional costs involved, so I try to hold down costs for each round that is necessary. I do not expect to need to roll positions more than once, if that, before we see the benefit of this strategy work. I want to discuss risk for a moment now. Obviously, if the market continues higher beyond January 2016 all of our new option contracts could expire worthless. I have never found insurance offered for free. We could lose all of our initial premiums paid plus commissions. If I expected that to happen I would not be using the strategy myself. But it is one of the potential outcomes and readers should be aware of it. And if that happens, I will initiate another round of put options for expiration beyond January 2016, using from up to three percent of my portfolio to hedge for another year. The longer the bull maintains control of the market the more the insurance will cost me. But I will not be worrying about the next crash. Peace of mind has a cost. I just like to keep it as low as possible. Because of the uncertainty in terms of how much longer this bull market can be sustained and the potential risk versus reward potential of hedging versus not hedging, it is my preference to risk a small percentage of my principal (perhaps as much as three percent per year) to insure against losing a much larger portion of my capital (30 to 50 percent). But this is a decision that each investor needs to make for themselves. I do not commit more than five percent of my portfolio value to an initial hedge strategy position and have never committed more than ten percent to such a strategy in total before a major market downturn has occurred. The ten percent rule may come into play when a bull market continues much longer than expected (like three years instead of 18 months). And when the bull continues for longer than is supported by the fundamentals, the bear that follows is usually deeper than it otherwise would have been. In other words, I expect a much less powerful bear market if one begins early in 2015; but if the bull can sustain itself into late 2015 or beyond, I would expect the next bear market to be more like the last two. If I am right, protecting a portfolio becomes ever more important as the bull market continues. As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other’s experience and knowledge. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: I hold at least one put option position (multiple contracts) in each of the stocks listed in this article.