Putting A Collar On The Dogs Of The Dow

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2020 was tough year for the Dogs of the Dow. The strategy backtest shows a loss of 7%, while the Dow Jones index was up 6%. Could returns have been improved with the use of options? Yes, it could.

Applying a collar to the Dogs of the Dow limits the losses.

Let’s backtest this for 2020 and look at the numbers.

We will:

  • Sell cash-secured puts to acquire the stocks at a discount
  • Then use covered calls to further reduce cost basis
  • If stock drops, put a collar on the Dog by buying a protective put

The Dogs of the Dow

The Dogs of the Dow are the 10 out of the 30 Dow Jones Index stocks that have the highest dividend yield. The investor holds these ten for a year. That’s it.

It is a mechanical strategy. No need to look at technicals or fundamentals. The sole selection criteria is the dividend yield and that it be part of the Dow Jones Index.

Dividend Yield

The dividend yield is the dividend payout divided by stock price. The dividend yield tends to be high for stocks that have dropped and are attractive to value investors. We can call them good value, or we can call them under-performing (as the term “dogs” would imply).

You need to make sure the yields are within reason. Double-digit yields are a red flag because it may mean that the stock price has dropped too much. This usually does not happen on Dow stocks which is why we limit our selection to these.

Results of the Dogs of the Dow Strategy in 2020

Suppose that an investor implements the strategy for year 2020 by buying roughly $10000 worth of each of the 10 Dogs of the Dow. We rounded to the nearest 100 shares.

dogs of the dow

At the end of one year, the net loss is around $8000, or 7%. Not too good for the Dogs.

Why the Dogs of the Dow Failed

Like most buy-and-hold strategies, the Dogs of the Dow strategy typically does not use a stop-loss. This was the downfall in 2020 due to the severe sell-off in March. XOM dropped 41% during the year. And there was no mechanism in place to stem that loss.

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Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

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