Dogs of the Dow Option Strategy

12/16/2012 8:00 am EST

Focus: STOCKS

Mike Scanlin

CEO, BornToSell.com

Investors have been using the Dogs of the Dow strategy for years. Here, Mike Scanlin of BornToSell.com offers an options twist to the usual equity play.

This conservative, value, and income-oriented strategy involves buying and holding the highest yielding Dow 30 stocks. Fans of the strategy make portfolio adjustments once per year, making sure their holding period is 366 days or more so that they get long-term capital gains treatment.


Historically, it has been a winning strategy, beating the market in several time frames (for year ending 12/31/2011):

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However, it doesn't beat the market every year:

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(Thanks to dogsofthedow.com for these charts.)
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Better Dogs
Combining the Dogs of the Dow strategy with a covered call strategy appeals to income-oriented investors. By selling out-of-the-money call options against their positions, they get extra dividends from these already high-yielding stocks.

Most of the so-called "dogs" aren't high-flying momentum stocks, so you may have to write options longer dated than near-month to get enough premium to make it worthwhile. But, since these are buy-and-hold positions, the low maintenance of multi-month contracts can be a plus a well.

Current Dogs of the Dow
The top 10 highest-yielding Dow 30 stocks today are:

Company Symbol Dividend Yield
AT&T T 5.3%
Verizon VZ 4.6%
Intel INTC 4.5%
DuPont DD 4.0%
Merck MRK 3.8%
Hewlett-Packard HPQ 3.8%
McDonalds MCD 3.5%
Microsoft MSFT 3.5%
Johnson & Johnson JNJ 3.5%
Pfizer PFE 3.4%

Improving Dog Yield With Covered Calls
Now, let's run these high-yield stocks through the Born To Sell's covered call screener to find some buy-write candidates for the January 19 expiration (5 weeks from today). Since we plan to hold these beyond the expiration date, we'll look at options that are at least 2% out of the money.

Here are the top 10 results when sorted by Annualized Return If Flat (meaning the stock price is unchanged between today and expiration) for the Jan 19, 2013, expiration:

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The red date (Jan 17) on the INTC row is warning us that there is an earnings announcement prior to the option expiration day (Jan 19). The green dates (Jan 8) are telling us that there is an ex-dividend date prior to the option expiration day (and, yes, the return calculations do include the dividend payment along with the option premium).

If you want to go a bit further out, let's look at the top 8 results for the Feb 16, 2013, expiration:

chart
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The farther out you go, the more you'll be subject to earnings announcements, but you'll also get more time premium. For example, from the two tables above, compare the HPQ 15-strikes: The January offers 50 cents of time premium while the February offers 78 cents of time premium. Depending on your transaction costs (as well as your outlook for the stock), it may be better to sell the Feb option than the Jan option.

But no matter which strike or expiration date you choose, writing covered calls against these high yielding "dogs" will increase their yield and lower your portfolio volatility.

By Mike Scanlin, CEO, BornToSell.com

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