Proven Dogs of the Dow Strategy Delivers 98% Per Trade — So Far…

Looking back at market performance in 2016, investors should be relatively pleased. The SPDR S&P 500 ETF (NYSE: SPY) gained 9.6% and, as usual, dividends added substantially to that percentage, bringing the total return for the year to 12%.

The SPDR Dow Jones Industrial Average ETF (NYSE: DIA) did even better, returning 13.5% and 16.4% with dividends.

That’s certainly not bad, but for the past four years, I’ve been sharing a strategy with investors around this time that has blown these returns out of the water — even without dividends. 

For 2016, this strategy delivered an average gain of 61% per trade, and it averaged 168% in 2014 and 176% in 2013. We did book an average loss in 2015 of 12% per trade as the broader market eked out just over a 1% gain (thanks solely to dividends). But if you had followed my recommendations over the past four years, you would have booked an average profit of roughly 98% per trade.

So, what is this strategy that has substantially beaten the market in three of the past four years?

It’s my twist on the Dogs of the Dow.

The Dogs of the Dow is a popular trading strategy that involves buying the 10 highest-yielding stocks in the Dow Jones Industrial Average, which is comprised of 30 of the largest — and arguably safest — companies in the world.

The idea is that higher yields indicate better value. Stock prices and yields have an inverse relationship, so high yields sometimes mean undervalued stocks that offer the opportunity for above-average returns.

Indeed, the strategy appears to deliver on that. Between 1973 and 1996, the Dogs returned 20.3% annually versus 15.8% for the Dow. And since 2000, the Dogs have gained an average of 7.9% a year while the Dow is up an average of 6.3% a year.

The basic strategy involves investing an equal amount of money in each of the 10 stocks on Dec. 31 and holding them for one year. But for the past few years, I’ve shared a variation of this strategy with Profitable Trading readers.

You may have heard of the popular variation called the Small Dogs of the Dow, which involves buying the five lowest-priced Dogs. My twist is that, rather than use actual shares of those companies for the strategy, I use long-term call options. (Just like the original strategy, I also sell these call options on the last trading day of the year, even though there’s still more time till expiration.)

Last year, I recommended calls expiring in January 2017, which gave 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. The table below shows the results when the positions were closed on Dec. 30 (the last trading day of 2016): 

During that same period, the average return for the buy-and-hold strategy for these five stocks would have resulted in a gain of just 18%, including dividends.

This year, the 2017 Small Dogs of the Dow and their corresponding January 2018 call options are: 

Buying these five call option contracts would cost about $1,768 (each contract controls 100 shares of the underlying stock). 

Because buying these five option contracts costs 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 can be invested in another strategy, which provides 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 2017, investors following a buy-and-hold strategy with the Dogs of the Dow could lose much more than that in dollar terms.

As my Dogs of the Dow strategy shows, options are a powerful tool for reducing risk and blowing stock returns out of the water. 

If you’re interested in using options to change your financial future in 2017, one of my colleagues has put together a free report detailing how he uses simple call and put options to earn 5-10 times as much per trade as average investors. You can access it for free here.