Small Dogs of the Dow Trades 2022 - Part One - Cabot Wealth Network

Small Dogs of the Dow Trades 2022 – Part One

dogs-of-the-dow-2022-poor-mans-covered-calls

Happy New Year!

As I have promised over the past few weeks, I’m going to introduce the new Dogs of the Dow positions over the course of the next few trading days.

At the beginning of every calendar year, I make any necessary adjustments needed for my longer-term poor man’s covered call (long diagonal debit spread) portfolios. I follow numerous proven investment strategies introduced by the likes of Ray Dalio, James O’Shaugnessy, Martin Zweig, Wayne Thorp and numerous other strategists. I also use simple, proven long-term approaches like All-Weather, Dogs of the Dow, Sector Rotation, Commodities Strategy and a few others in an constant effort to keep risk management at the forefront by using various options strategies.

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Andy Crowder quit a lucrative job on Wall Street so that he could share his expertise with regular investors – instead of super-rich investment banks and hedge funds.

Today, he publishes four different specialized options services for Cabot Wealth Network.

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These services each offer a safe way to generate reliable returns – based on statistical likelihoods that give you an 80% chance of success.

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Over the next few days I’m going to focus on the Dogs of the Dow, releasing several trades a day throughout the week. By the end of the week I will have all 10 trades/positions established.

Here are the 10 Dogs of the Dow stocks for 2022.

dogs-of-the-dow-2022

Source: Dogs of the Dow

If you wish to read more about the Dogs and my approach please check out the prior posts and comments section.

Today I’m going to start with a few trades in the Small Dogs of the Dow, including Dow (DOW) and Verizon (VZ).

Dogs of the Dow – Long Call Diagonal Spread (Poor Man’s Covered Call Strategy)

Dow (DOW)

There are numerous ways to approach poor man’s covered calls. My preference is to use LEAPS that have at least two years left until expiration.

For example, let’s take a look at Dow (DOW). It’s a fairly expensive stock and that can be a huge deterrent for many investors; not with a poor man’s covered call.

As you can see in the chart below the stock is currently trading for 58.40.

dow-dogs-of-the-dow-poor-mans-covered-calls

Now, if we followed the route of the traditional covered call we would need to buy at least 100 shares of the stock. At the current share price, 100 shares would cost $5,840. That’s certainly not a crazy amount of money. But just think if you wanted to use a covered call strategy on, say, a higher-priced stock like Apple (AAPL), Microsoft (MSFT) or even an index ETF like SPDR S&P 500 ETF (SPY). For some investors, the cost of 100 shares can be prohibitive, especially if diversification amongst a basket of stocks is a priority. Therefore, a covered call strategy just isn’t in the cards…and that’s unfortunate.

But with a poor man’s covered call strategy you can typically save 55% to 85% off the cost of a covered call strategy.

So again, rather than purchase 100 shares or more of stock, we only have to buy one LEAPS call contract for every 100 shares we wish to control.

As I said before, my preference is to buy a LEAPS contract with an expiration date around two years. Some options professionals prefer to only go out 12-16 months, but I prefer the flexibility the two-year LEAPS offers.

The image below shows every expiration cycle available for Dow. Again, I want to go out roughly two years in time. The January 19, 2024 expiration cycle with 745 days left until expiration is the longest dated expiration cycle and would be my choice.

So, when my LEAPS reach 10-12 months left until expiration I then begin the process of selling my LEAPS and reestablishing a position with approximately two years left until expiration.

Dow-expiration-cycles-poor-mans-covered-call

Once I have chosen my expiration cycle, I then look for an in-the-money call strike with a delta of around 0.80.

When looking at Dow’s option chain I quickly noticed that the 42.5 call strike has a delta of 0.79. The 42.5 call strike price is currently trading for approximately $17.75. Remember, always use a limit order. Never buy an option at the ask price, which in this case is $18.75.

So, rather than spend $5,840 for 100 shares of Dow, we only needed to spend $1,775. As a result, we saved $4,065, or 69.6%. Now we have the ability to use the capital saved to diversify our premium amongst other securities, if we so choose.

Dow-LEAPS-2024-poor-mans-covered-calls

After we purchase our LEAPS call option at the 42.5 strike, we then begin the process of selling calls against our LEAPS.

My preference is to look for an expiration cycle with around 30-60 days left until expiration and then aim for selling a strike with a delta ranging from 0.20 to 0.40, or a probability of success between 60% and 85%.

As you can see in the options chain below, the 60 call strike with a delta of 0.40 falls within my preferred range.

Dow-short-calls-poor-mans-covered-calls

We could sell the 60 call option for roughly $1.60.

Our total outlay for the entire position now stands at $16.15 ($17.75 – $1.60). The premium collected is 9.0% over 45 days.

If we were to use a traditional covered call our potential return on capital would be less than half, or 2.7%.

And remember, the 9.0% is just the premium return, it does not include any increases in the LEAPS contract if the stock pushes higher. Moreover, we can continue to sell calls against our LEAPS position for another 8 – 12 months, thereby generating additional income or lowering our cost basis even further.

An alternative way to approach a poor man’s covered call, if you are a bit more bullish on the stock, is to buy two LEAPS for every call sold. This way you can benefit from the additional upside past your chosen short strike, yet still participate in the benefits of selling premium.

Now let’s try the same poor man’s covered call approach with Verizon.

Verizon (VZ)

As you can see in the chart below Verizon stock is currently trading for 53.30.

verizon-VZ-poor-mans-covered-calls

Now, if we followed the route of the traditional covered call we would need to buy at least 100 shares of the stock. At the current share price, 100 shares would cost $5,330. Again, not a crazy amount of money. But for some investors, the cost of 100 shares can be prohibitive, especially if diversification amongst a basket of stocks is a priority. Therefore, a covered call strategy just isn’t in the cards…and that’s unfortunate.

But with a poor man’s covered call strategy you can typically save 55% to 85% of the cost of a covered call strategy.

So again, rather than purchase 100 shares or more of stock, we only have to buy one LEAPS call contract for every 100 shares we wish to control.

As I said before, my preference is to buy a LEAPS contract with an expiration date around two years. Some options professionals prefer to only go out 12-16 months, but I prefer the flexibility the two-year LEAPS offers.

The image below shows every expiration cycle available for Verizon. Again, I want to go out roughly two years in time. The January 19, 2024 expiration cycle with 745 days left until expiration is the longest dated expiration cycle and would be my choice.

So, when my LEAPS reach 10-12 months left until expiration I then begin the process of selling my LEAPS and reestablishing a position with approximately two years left until expiration.

Verizon-VZ-expiration-cycles-poor-mans-covered-calls

Once I have chosen my expiration cycle, I then look for an in-the-money call strike with a delta of around 0.80.

When looking at Verizon’s option chain I quickly noticed that the 45 call strike has a delta of 0.80. The 45 call strike price is currently trading for approximately $8.85. Remember, always use a limit order. Never buy an option at the ask price, which in this case is $895.

So, rather than spend $5,330 for 100 shares of Verizon, we only needed to spend $885. As a result, we saved $4,445, or 83.4%. Now we have the ability to use the capital saved to diversify our premium amongst other securities, if we so choose.

Verizon-VZ-LEAPS-poor-mans-covered-calls

After we purchase our LEAPS call option at the 45 strike, we then begin the process of selling calls against our LEAPS.

My preference is to look for an expiration cycle with around 30-60 days left until expiration and then aim for selling a strike with a delta ranging from 0.20 to 0.40, or a probability of success between 60% and 85%.

As you can see in the options chain below, the 55 call strike with a delta of 0.24 falls within my preferred range.

Verizon-VZ-short-calls-poor-mans-covered-calls

We could sell the 55 call option for roughly $0.36.

Our total outlay for the entire position now stands at $8.49 ($8.85 – $0.36). The premium collected is 4.1% over 45 days.

If we were to use a traditional covered call our potential return on capital would be less than half, or 0.7%.

And remember, the 4.1% is just the premium return, it does not include any increases in the LEAPS contract if the stock pushes higher. Moreover, we can continue to sell calls against our LEAPS position for another 8 – 12 months, thereby generating additional income or lowering our cost basis even further.

As with our Dow trade, if you are a bit more bullish on Verizon stock, you can buy two LEAPS for every call sold. This way you can benefit from the additional upside past your chosen short strike, yet still participate in the benefits of selling premium.

Regardless of your approach, you can continue to sell calls against your LEAPS as long as you wish. Whether you hold a position for one expiration cycle or 12, poor man’s covered calls give you all the benefits of a covered call for significantly less capital.

As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.

Comments

  • Brad D.

    At what profit point do you buy back your short call? Or do you let them expire worthless?

    And so I’m clear, if your short call goes in the money close to expiration, you buy it back for a loss? And you also sell your leap to make up that loss?

    • Andy C.

      Brad,

      Thanks for the question. It’s one of the most asked questions I receive. I allow the price and current probability of success dictate whether or not I buy my short call back or simply allow the call to expire worthless. There are varying factors that come into play, so giving a definitive answer, in this forum, just isn’t practical. That being said, I think an article (and a video) with a few examples could be helpful. So, I’ll work that into my agenda over the next week or so. As for your second question, I always hold on to my LEAPS position. The only time I sell my LEAPS contract is if the delta pushes below .50 or if my LEAPS contract has 10-12 months until expiration, I simply sell the LEAPS contract and buy another LEAPS contract further out in time to eliminate any theta decay (time decay). I hope this helps.

      • Hey Andy –
        Did you post examples or a video anywhere about the ITM short call at expiration that I can study? I have a couple of positions in my Dogs of the Dow LEAPS portfolio that I need to manage. I had a position get exercised last Friday when I was away from the computer and the Margin Team cleaned it up for me nicely but I know that isn’t what I should do. Thank you so much for your advice. I have really enjoyed learning from your posts!

        • Lisa,

          I don’t have any videos up yet. Soon. As for an ITM short call, I typically buy them back prior to expiration to avoid assignment. However, it jut depends on my intent going forward. I hope this helps.

  • This is a great strategy if the stocks go up or stay where they are at. But if the stock market goes down, you would be highly leveraged and lose money quicker as compared to holding shares. You also won’t collect dividends. Do you have any risk mitigation or are you worried about the stocks falling. I think one of your mitigations is going two years out and selling the leaps after one year.

    • Andy C.

      Cory,

      Thanks for writing in. Unfortunately, you are not correct in your statement. You would not lose as much as holding shares. Take a look at the capital and overall delta of a traditional covered call versus that of a poor man’s covered call, particularly when initiating a LEAPS position with an .80 delta. The math clearly proves otherwise. Also, due to over five years of experience with the strategy using various underlyings, more often than not, the overall returns are greater using a poor man’s covered call strategyy during times of duress. Again, there are very few exceptions. And in the exception when return happens to be greater using a traditional covered call (during times of duress) the overall capital lost is still greater with a traditional covered call. Risk management is key, from choosing a LEAPS contract with an .80 delta as opposed to closer to 1, or strict position-size, or simply creating a hedge trade beyond selling the call (which again acts as a natural hedge since it lowers the cost basis each and every time you sell premium). I hope this helps clear up a few items. I can dig deeper into the discussion if you are still unclear about the intricacies of the strategy. Thanks again for writing in.

  • Maurice P.

    Thank you very much for your detailed description for setting up the PMCC, Andy. This was exactly what I was looking for.

    One quick question; in the Verizon example above, the current price is 53.30 and you sold the FEB 18 call with a strike of 55. Clearly that is fine if the price continues to decline, but what would you do if the price started to increase and you risked being exercised at the 55 strike before expiration on FEB 18? How would you manage the trade in that situation?

    Thank’s again for all your great posts. They have been incredibly helpful.

    Regards,

    Maurice

    • Andy C.

      Maurice,

      Thanks for writing in. The benefit of poor man’s covered calls over a traditional covered call is that we are not limited to the short call capping our upside gains. The overall position, when initiated, of a poor man’s covered call is delta positive. So even with the underlying hitting the short call strike the delta of the position will still be in a position to participate in upside gains…that is until the delta of the LEAPS contract is at parity with the short call. At that point, if not earlier, we buy back the short call and sell more short calls. Yes, we will lose out on the short call, but we will more than make up for any losses by the increase in the LEAPS contract. The reason is due to the higher deltas that exist in the LEAPS contract over the short call. I hope this helps.

  • New to options and trying to learn/understand. What happens when the call sto is met? Eg. VZ is 56 on 18feb22.. Do we close leap on that day to get 100 shares that will be called with sto call?

    • Andy C.

      Sekhar,

      Thanks for writing in. The benefit of poor man’s covered calls over a traditional covered call is that we are not limited to the short call capping our upside gains. The overall position, when initiated, of a poor man’s covered call is delta positive. So even with the underlying hitting the short call strike the delta of the position will still be in a position to participate in upside gains…that is until the delta of the LEAPS contract is at parity with the short call. In most cases, I only close the LEAPS contract when there is only 10-12 months left until expiration. Otherwise, I keep the LEAPS on and continue to sell more premium, that is unless my original intent is to initiate a shorter-term position. I hope this helps.

    • Andy C.

      Todd,

      Thanks for writing in. I do not take off the position around earnings. We are able to sell premium for inflated levels around earnings announcements. Of course, I will occasionally add a hedge around earnings to cover any unforeseen catastrophic losses, particularly if I am using a higher beta underlying stock. I hope this helps.

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