A Buy-Write 'Dogs Of The Dow' Strategy For 2012

by: Phil Fragasso

As a contrarian by nature, I've always been attracted to the Dogs of the Dow strategy. And while the strategy doesn't always work, its inherently high dividend yield provides some solace in falling markets. If you're anything like me, however, "solace" is not what you're looking for in an equity investment. So I've taken a look at a covered-call strategy that can provide significantly higher "yields" in a flat market and compelling double-digit returns in a rising market.

Because the Dogs of the Dow approach is based on a one-year buy-and-hold, my illustration uses LEAP options expiring in January 2013. The following table highlights ten potential trades that - if the respective stock prices remained unchanged through January 19, 2013 - would offer guaranteed realized returns ranging from 5.47% to 9.72%. If the underlying stocks were to hit the LEAP strike price, then the prospective maximum returns would range from 13.92% to 23.83%.

Here's how to read the table using Intel as an example. On Friday December 30, INTC closed at $24.25. You could have sold a January 2013 call with a strike price of $27.00 for $1.35. During the one-year period that you held the position, you would have received a dividend of $0.84. The option premium of $1.35 plus the $0.84 dividend would result in a return of 9.03%. If Intel were to be at or above the strike price of $27.00, the stock would be called away and you would enjoy a return of 20.37% (the $1.35 option plus the $0.84 dividend plus the cap gain of $2.75).

I've chosen strike prices that I believe are achievable and that offer a sufficient premium to offset the fact that I'd be giving up some upside if the underlying stock were to soar. As you conduct your own analysis of these trades, you may want to use a lower strike price (which would offer a higher premium and thus increase your minimum return while lowering your maximum return). Alternatively you could sell a higher strike and trade off a lower minimum return with a higher maximum return. No single approach is correct for every investor, so choose your spots wisely

Disclosure: I am long VZ.