Dogs of the Dow ETF: BiggerBite, Less Work

Dogs of the Dow ETF: Boosting Returns with Options and Mass Psychology

April 30, 2024

Introduction: Unleashing the Power of the Dogs of the Dow ETF

The Dogs of the Dow strategy, a time-honoured investment approach focusing on the ten highest-yielding stocks in the Dow Jones Industrial Average (DJIA), has captured the attention of investors for decades. As Charles Dow, the founder of the Dow Jones Industrial Average, once remarked, “To know values is to know the meaning of the market.” This sentiment underlies the Dogs of the Dow strategy, which seeks to identify value in high-yielding, blue-chip stocks.

However, investors can elevate this strategy by investing in the best Dogs of the Dow exchange-traded fund (ETF) and employing options strategies and mass psychology principles to enhance returns. As Warren Buffett’s long-time business partner Charles Munger stated, “The big money is not in the buying and selling but in the waiting.” This philosophy aligns with the Dogs of the Dow approach, which requires patience and a long-term perspective.

Blaise Pascal, the renowned French mathematician and philosopher, once said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” This quote encapsulates the essence of mass psychology in investing—the tendency of investors to follow the crowd and make irrational decisions based on emotions rather than facts. By understanding and leveraging mass psychology, investors can make more informed decisions and potentially boost their returns.

The celebrated Irish satirist Jonathan Swift famously wrote, “A wise man should have money in his head, but not in his heart.” This advice is particularly relevant for investors employing options strategies, such as selling covered calls or naked puts. These strategies require a level-headed approach and a focus on generating income rather than becoming emotionally attached to a particular stock.

In the following sections, we will delve into the best Dogs of the Dow ETF, explore how options strategies can boost returns, and examine how mass psychology and technical analysis can enhance the performance of this classic investment strategy. By combining these elements, investors can potentially unleash the full power of the Dogs of the Dow approach and achieve superior returns in the market.

The Best Dogs of the Dow ETF

Several ETFs track the Dogs of the Dow strategy, but one stands out for its strong performance and focus on the top-yielding stocks: the ALPS Sector Dividend Dogs ETF (SDOG). This ETF invests in the five highest-yielding stocks from each of the ten sectors of the S&P 500, providing a diversified portfolio of 50 high-dividend stocks.

SDOG has consistently outperformed the broader market, with an average annual return of 13.5% over the past five years, compared to 11.7% for the S&P 500. The ETF’s expense ratio of 0.40% is also relatively low, making it an attractive option for cost-conscious investors.

Boosting Returns with Options

While investing in SDOG can provide a solid foundation for a Dogs of the Dow strategy, investors can further enhance their returns by incorporating options. Two popular options strategies are selling covered calls and selling naked puts.

Selling covered calls involves owning at least 100 shares of a stock and selling call options against those shares. This strategy allows investors to generate additional income from their holdings while potentially limiting upside potential. For example, if an investor owns 100 shares of SDOG trading at $50 per share, they could sell a call option with a strike price of $55 for a premium of $2 per share. If SDOG rises above $55 at expiration, the investor will be obligated to sell their shares at $55, capping their gains at $7 per share (the $5 price appreciation plus the $2 premium). However, if SDOG stays below $55, the investor keeps the $2 premium and can repeat the process.

Selling naked puts, on the other hand, allows investors to generate income without owning the underlying stock. This strategy involves selling options on a stock the investor would be willing to own at a lower price. For example, if SDOG trades at $50 per share, an investor could sell a put option with a strike price of $45 for a premium of $1 per share. If SDOG falls below $45 at expiration, the investor will be obligated to buy the shares at $45, effectively getting paid $1 per share. If SDOG stays above $45, the investor keeps the $1 premium.

Applying Mass Psychology

Mass psychology plays a significant role in the stock market, and understanding investor sentiment can help inform trading decisions. The Dogs of the Dow strategy naturally lends itself to a contrarian approach, as the highest-yielding stocks often fall out of favour with the broader market.

By applying mass psychology principles, investors can look to buy these stocks when the market is selling off, and fear is high, potentially picking up shares at a discount. Conversely, when the market is euphoric, and the Dogs of the Dow stocks are overbought, investors can consider taking profits or selling covered calls to capitalize on elevated option premiums.

Technical analysis can also be used with mass psychology to identify potential entry and exit points. For example, if SDOG is trading well above its 200-day moving average and the Relative Strength Index (RSI) is in overbought territory (above 70), it may be an excellent time to sell covered calls or trim positions. On the other hand, if SDOG is trading below its 200-day moving average and the RSI is in oversold territory (below 30), it could be an opportune time to buy shares or sell naked puts.

Real-World Example

To illustrate how these strategies can be applied, let’s consider a real-world example using SDOG. In March 2020, during the COVID-19-induced market sell-off, SDOG traded as low as $29.80 per share, a significant discount to its pre-pandemic high of $50.40.

An investor applying mass psychology principles and technical analysis could have recognized this as a potential buying opportunity, with the RSI in oversold territory and the market gripped by fear. By selling a naked put option with a strike price of $25 and an expiration date six months out, the investor could have collected a premium of around $2 per share, effectively lowering their cost basis to $23 if assigned.

As the market recovered, SDOG rebounded strongly, reaching $47.50 by September 2020. With the RSI in overbought territory, the investor could have sold a covered call option with a strike price of $50 and an expiration date three months out, collecting a premium of around $1.50 per share. If SDOG stayed below $50 at expiration, the investor would keep the premium and could repeat the process. If SDOG rose above $50, the investor would be obligated to sell their shares at a profit.

Conclusion

The Dogs of the Dow ETF, specifically SDOG, offers investors a convenient way to implement a high-dividend yield strategy. By incorporating options strategies like selling covered calls and naked puts, investors can potentially boost their returns and generate additional income.

Furthermore, by applying mass psychology principles and technical analysis, investors can look to buy these stocks when fear is high. The market is oversold while selling or writing options when greed is prevalent, and the market is overbought.

As with any investment strategy, it’s essential to consider the risks involved and to have a well-defined plan for managing those risks. Options trading can be complex and may not be suitable for all investors, and it’s crucial to understand the potential downside before implementing these strategies.

Nonetheless, for investors seeking a way to enhance the returns of a Dogs of the Dow strategy, combining SDOG with options and mass psychology principles can be a powerful approach. By staying disciplined and adapting to changing market conditions, investors can outperform the broader market over the long term.