How to Score Outsized Profits on the Dogs of the Dow in 2015

Some traders argue that once an indicator or strategy is well known it loses its effectiveness. But that doesn't seem to ring true for the Dogs of the Dow, which was popularized in the early '90s.

The Dogs are the 10 highest yielding stocks in the Dow Jones Industrial Average, which is comprised of 30 of the largest -- and arguable safest -- companies in the world. 

The idea is that the higher yields indicate better value, and the chance for above-average returns. And indeed, the strategy does appear to deliver on that. Between 1973 and 1996, the Dogs returned 20.3% annually versus 15.8%for the Dow. In 2013, the Dogs beat the Dow 30 by 8.4 percentage points, returning 35%.

Following the basic strategy involves investing an equal amount of money in each of these 10 stocks on Dec. 31, and holding them for one year. But for the past two years, I've shared a variation of this strategy with Profitable Trader readers that has delivered triple-digit profits. 

While the Dogs had a great year in 2013, when I reviewed my strategy in mid-December of last year, a $1,089 investment had already grown to over $3,000 -- a roughly 175% return.

You may have heard of the popular variation called the Small Dogs of the Dow, which involves buying the five lowest-priced Dogs. This strategy has beaten the traditional Dogs in the past one-, three-, five-, 10- and 20-year periods. 

My twist is this: I buy long-term call options on the Small Dogs of the Dow.

Last year, I recommended calls expiring in January 2015, which would give us exposure to the stocks for one year. To minimize trading costs, I chose calls with strike prices as close as possible to the stock's price at the time. As the table below shows, it was another banner year:

2014 Dogs of the Dow
Stock Jan 2015 Strike Cost Closing Price* Profit/Loss
Cisco Systems (NASDAQ: CSCO) $20 $2.16 $8.20 279.6%
Intel (NASDAQ: INTC) $25 $2.17 $11.82 444.7%
Pfizer (NYSE: PFE)
$30 $2.43 $1.51 -37.9%
AT&T (NYSE: T) $33 $2.40 $1.12 -53.3%
Microsoft (NASDAQ: MSFT) $35 $3.90 $12.03 208.46%
Average Return       168.3%
*As of Dec. 30 close

This strategy significantly outperformed buying and holding these five stocks. Had you invested in the stock of each company in equal amounts, you would have enjoyed an average gain of 22.8%. For the second year in a row, the Small Dogs of the Dow had a great year, but my call option strategy did more than seven times better.

This year, my recommended January 2016 call options on the Small Dogs of the Dow are:

2015 Dogs of the Dow
Stock Jan 2016 Strike Cost*
General Electric (NYSE: GE) $25 $1.80
Pfizer (NYSE: PFE) $32 $1.71
AT&T (NYSE: T) $35 $1.27
Coca-Cola Company (NYSE: KO) $42 $3.05
Verizon Communications (NYSE: VZ) $47 $2.65
Total   $10.48
*As of Dec. 30 close

Buying these five call option contracts would cost about $1,048 (each contract controls 100 shares of the underlying stock). Because these five option contracts would cost much less than buying 100 shares of each of the stocks, traders can commit a smaller amount of funds to this strategy. 

The trading capital saved by using call options could be invested in another strategy, providing diversification and the opportunity for additional gains.

The risk is limited to the price paid for the options. If we get a significant correction or even enter a bear market in 2015, 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
-- Do not use stop-losses
-- Close all trades at the end of 2015

Note: I'd like to mention one more options strategy for you to consider in the new year. Using this simple, income-generating method, I have earned average annualized gains of 43% on my way to a perfect 78 for 78 track record. If you'd like to learn more and receive my trades in 2015, just follow this link to get started.

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