The basic idea behind the Dogs of the Dow is to buy the 10 highest yielding stocks in the Dow Jones Industrial Average and rebalance the portfolio once a year. The Dow Jones Industrial Average contains 30 of the biggest companies in the world. There is little risk that a company can go into bankruptcy while it is a member of the Dow, and that reduces the risk of buying the stocks. The Dogs are the stocks that offer the best value, using the dividend yield as a measure of value. Over time, the strategy is expected to outperform the index.
Most studies agree that the Dogs of the Dow is an effective stock-picking strategy with the results at least matching the buy-and-hold returns available from the index over the long term.
One of the variations of the strategy is to buy only the five lowest priced stocks from the list of the 10 highest yielding stocks. Most studies find this approach does better than a buy-and-hold strategy.
My recommended variation is to buy long-term call options on the five lowest priced, high-yielding stocks. Last year, I recommended calls expiring in January 2014 that would give us exposure to the stocks for one year. To minimize trading costs, I recommended calls with strike prices as close as possible to the stock's price at the time. The exact options are shown in the table below.
*As of Dec. 19 openThis strategy significantly outperformed buying these five stocks. The gain in the stocks would have been 22.5%. Dividends could have added another 4% or so to the strategy. The Dogs of the Dow had a great year, but my call option strategy did more than six times better.
This year, the five lowest priced, high-yielding stocks and my recommended January 2015 call options are:
The risk is limited to the price paid for the options. In the unlikely event that all five stocks fall to zero, the trader would lose less than $1,306. If we see a new bear market in 2014, or a significant sell-off in stocks, investors following a buy-and-hold strategy with the Dogs of the Dow stocks could lose much more than that in dollar terms.
Recommended Trade Setup:
-- Buy the five call options identified above to duplicate the Dogs of the Dow strategy
-- Do not use stop-losses
-- Close all trades at the end of 2014
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