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2020 has been a tough year for the Dogs of the Dow.
The strategy backtest shows a loss of 7%, while the Dow Jones index rose by 6%.
Could the use of options have improved returns?
Yes it could.
Attaching a collar to the Dogs of the Dow limits the losses.
Let’s test this for 2020 and look at the numbers.
We will…
The Dogs of the Dow are the 10 out of 30 Dow Jones Index stocks with the highest dividend yield.
The investor holds these ten for one year.
That’s it.
It’s a mechanical strategy.
No need to look Technical specifications or basics.
The only selection criterion is the dividend yield and that it is part of the Dow Jones Index.
The dividend yield is that dividend Payout divided by the share price.
The dividend yield tends to be high for stocks that have fallen and are attractive to value investors.
We can call them cheap or underperforming (as the term “dogs” would imply).
You need to make sure that the returns are within reason.
Double digit returns are a red flag as it may mean the stock price has fallen too much.
This is typically not the case with Dow stocks, which is why we’re limiting our picks to these.
For example, let’s say an investor executes the 2020 strategy by buying around $ 10,000 worth of each of the 10 Dogs of the Dow.
We have rounded to the nearest 100 shares.
At the end of a year, the net loss is around $ 8,000, or 7%.
Not so good for the dogs.
Like most buy and hold strategies, the Dogs of the Dow strategy does not typically use a stop loss.
That was the drop in 2020 due to the heavy sell-off in March. XOM fell 41% over the year.
And there was no mechanism to contain that loss.
Then why did the dogs do the worst than the Dow Index?
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The idea behind the strategy is not only to generate high dividends, but also to take advantage of the industry rotation in the market.
The idea is to buy undervalued stocks that will eventually turn into favor again.
Unfortunately, this rotation can sometimes take years. Dogs can stay dogs.
Underperformers may continue to perform below average until they are removed from the list.
All of our dogs at the start of 2020 remained dogs at the start of 2021, with the exception of Pfizer (PFE) and ExxonMobil (XOM).
Not because they outperformed the others, but because they were dropped from the Dow Jones Index.
Step 1: Sell cash backed puts to buy stocks
To sell Cash backed puts A strike out of the money with a monthly expiration of 30 days or less.
Hold until the expiry.
If assigned, we acquire the share.
If not allocated, we keep the premium received and sell another put.
Step 2: Sell Covered Calls
Once stocks of a stock are purchased, they sell covered calls with a monthly expiry of a maximum of 30 days.
When the 20-day moving average falls, you’re selling calls a beat out of the money.
If it drops, you’re selling calls a punch in the money.
Otherwise, you’re selling calls for the money.
Step 3: buy a protective put to complete the collar
Protection puts are expensive to buy, so we only buy when we need them.
If the stock price is more than 5% below the price it was purchased at, buy protection that is an out-of-the-money strike below its current price.
Use the same expiration date that you used for the covered call.
That position is now one collar.
If we have one in a nutshell but no share yet, buy a protective put if the share price is more than 5% below the strike price of our short put.
Buy the Put One Strike out of the money below the current price to turn it into one Bull put spread.
This limits the loss of a cash backed short put.
If we hold a stock position beyond an acquisition date, we will collapse the stock by buying the protective put.
If a short put has a profit date, we also buy the protection put.
Our Quick call and short put strikes are very close to the money and sometimes in the money.
This is because we don’t mind if our stocks are retrieved and we don’t mind if our puts are assigned to repurchase the stocks.
Because at-the-money options have the highest time value, selling them and waiting for them to expire will make us generate the most Theta.
Selling in-the-money calls is a valid strategy under certain conditions.
It lowers the break-even price.
If the stock does not move and be called, we will still make money. In general, sell out-of-money calls when you are bullish.
Sell money calls when they’re bearish.
Likewise, there is nothing inherently wrong with buying in-the-money protection puts.
There is also nothing wrong with selling cash-backed puts for the money.
Here are the results of the option strategy in comparison …
While it was still a loss for the year, the loss was much smaller as the options strategy uses the collar to limit losses on stock positions and uses put spreads to limit losses on short puts.
The Collar position is long stock and selling one covered calland buy a Put protection.
It limits the profits and limits the losses.
The long, covered call, and collar positions are all bullish strategies – the difference is the size of the bullish position.
They do better when the stock goes up.
You do worst when the stock falls.
Walgreens (WBA) performed worst on both equity and options strategies.
The loss when using the option strategy was less.
Dow Inc (DOW) has done its best in both stock and options strategy. The gains were greater when using the option strategy.
None of the 10 Dogs of the Dow stocks beat the Dow Jones Index.
Instead of picking the dogs of the Dow, how about you picking the Dow leaders.
AAPL, MSFT, NKE, CRM, and DIS had the largest capital appreciation in 2020 (excluding dividends).
If we use Barchart’s comparison function with a specific date range, we can clearly see that these five outperformed the index in 2020.
Although past performance does not guarantee future success.
We leave it to the reader as an exercise Backtest this using the option strategy.
You may also want to test different strike selection or expiration periods.
Here is an example of how we retest a symbol:
The dividend payouts and earnings data were from nasdaq.com.
We looked at the ex-dividend day to see if any dividend payouts were made.
The historical option prices were obtained using OptionNet Explorer with end-of-day dates.
The covered call is sold and the protection put is bought on the next trading day after the expiration date.
The dividend yield on 30 Dow Jones stocks for a given year can be found at Dogsofthedow.com.
As this particular backtest from 2020 shows, options that are used responsibly can offer advantages over just investing in stocks. That’s why we love her !!
Trade safe!
Gav.
Disclaimer: The information above applies to For educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are unfamiliar with exchange-traded options. All readers interested in this strategy should do their own research and seek advice from a licensed financial advisor.
