I came across an interesting article on SeekingAlpha where the author suggests a strategy for exploiting the high yields of the Dogs of the Dow (I recently wrote on the 2012 Dogs of the Dow) mixed with selling long-dated options (LEAPS) on those positions. Using Dow stocks also tends to minimize the risk of outright collapse in a stock as well, as they tend to be a bit more stable than smaller, less recognized companies. While it’s a lot to manage all those positions and options contracts, the beauty of selling covered call options is that you’re capturing the premium as it drops off over time since most options expire worthless. And if the stock runs and the shares get called, you had the gain on the underlying stock AND the premium on the option.
The author used a methodology whereby he sold LEAPS out in 2013 and stated what the returns would be should shares remain FLAT or HIT THE STRIKE PRICE during that time. The returns look good, especially considering the low interest rate environment we’re in and the volatility stocks will likely face in the future. But there’s the rub. His analysis considers what happens if all shares are FLAT or MOVE UP, but not what happens if shares decline. When I model out such scenarios, I like to set up a spreadsheet and model the full range of prices both up and down. While the option premium and dividends can certainly blunt downward moves in share prices, you can still end up with a sizable loss, especially across such a long time horizon.
Interested in Your Thoughts – Would You Try This Strategy?
Have You Ever Sold Covered Calls?