How To Buy Options On the Dow Jones

The Dow Jones Industrial Common (DJIA) is a trademark index of 30 American blue-chip firms, which has been round for the reason that nineteenth century. The best and most cost-effective avenue to commerce the Dow Jones is thru an exchange-traded fund (ETF).

The oldest such ETF is the SPDR Dow Jones Industrial Common ETF Belief (DIA). or “Diamonds”, which tracks the DJIA and seeks to trace the worth and yield efficiency of the index, with every DIA share representing roughly 1/100^th of the index itself.

If in case you have restricted capital however wish to commerce the Dow, DIA ETF choices may be a great way to go, assuming you additionally perceive the dangers concerned with choices buying and selling. Learn on to see tips on how to purchase and use choices to commerce the Dow Jones.

Choices Fundamentals & Overview

For the needs of what follows, we’ll have a look at historic examples utilizing DIA choices that expired again in September 2015. We take this instance as a result of that expiration date got here lower than one month after the August 2015 “mini flash crash”, a market occasion that lifted the CBOE Market Volatility Index (VIX) above 50 for the primary time since 2009, significantly influencing pricing on the September 2015 contracts.  

The emphasis right here shall be on shopping for (or going “lengthy”) choices, in order that your danger is restricted to the premium paid for the choices, reasonably than methods that contain writing (or going “quick”) choices. Particularly, we deal with the next choice methods:

1. Lengthy Name
2. Lengthy Put
3. Lengthy Bull Name Unfold
4. Lengthy Bear Put Unfold

DIA Lengthy Name

• Technique: Lengthy Name on the DJIA ETF (DIA)
• Rationale: Bullish on the underlying index (DJIA)
• Choice chosen: September ’15 $184 Name
• Present Premium (bid/ask): 3.75 / $4.00
• Most Danger: $4.00 (i.e., choice premium paid)
• Break-even: DIA value of $187 by choice expiry
• Potential Reward: (Prevailing DIA value – break-even value of $188)
• Most Reward: Limitless

In case you are bullish on the Dow, you can provoke a protracted place (i.e. purchase) a name choice. The all-time excessive on the DIA again at that time was $183.35, which was reached on Might 20, 2015 — the identical day that the DJIA index opened at a peak of 18,315.10.

In case you thought that the worth would proceed to rise, the following highest strike value could be $184. A strike value of $184 merely means that you’d be capable of purchase DIA shares at $184, even when the market value have been larger at or earlier than expiration.

If the DIA models closed beneath $184 – which corresponds to a Dow Jones stage of about 18,400 – by choice expiry, you’d have solely misplaced the premium of $4 per choice that you just paid for the calls. Your break-even value on this selection place is $188 (i.e., the strike value of $184 + $4 premium paid). What this implies is that if the Diamonds closed precisely at $188 on September 18, the calls would expire at precisely $4, which is the worth that you just paid for them. Thus, you’d recoup the $4 premium paid if you purchased the calls, and your solely value could be the commissions paid to open and shut the choice place.

Past the break-even level of $188, the potential revenue is theoretically limitless. If the Dow soared to 20,000 earlier than expiration, the DIA models would go for about $200, and your $184 name would rise to $16, a tidy $12 revenue or 300% achieve in your name place.

DIA Lengthy Put

• Technique: Lengthy Placed on the DJIA ETF (DIA)
• Rationale: Bearish on the underlying index (the DJIA)
• Choice chosen: September’15 $175 Put
• Present Premium (bid/ask): $4.40 / $4.65
• Most Danger: $4.65 (i.e., choice premium paid)
• Break-even: DIA value of $170.35 by choice expiry
• Potential Reward: (Break-even value of $170.35 – Prevailing DIA value)
• Most Reward: $170.35

In case you have been as an alternative bearish, you can provoke a protracted put place. Within the instance described above, you’d be in search of the Dow to say no to at the very least 17,500 by choice expiry, representing a 4.9% drop from the start stage of 18,400.

If the DIA models closed above $175 – which corresponds to a Dow Jones stage of about 17,500 – by choice expiry, you solely would have misplaced the premium of $4.65 that you just paid for the places.

Your break-even value on this choices place is $170.35 (i.e., the strike value of $175 much less $4.65 premium paid). Thus, if the Diamonds closed precisely at $170.35 at expiration, the calls would commerce at your buy value of $4.65. In case you bought them at that value, you’d break even, with the one value incurred being the commissions paid to open and shut the choice place.

Under the break-even level of $170.35, the potential revenue is theoretically a most of $170.35, which might occur within the almost not possible occasion of the Diamonds dropping all the best way to $0 (which might require the DJIA index to even be buying and selling at zero!). Your put place would nonetheless generate profits if the Diamonds are buying and selling at any stage beneath $170.35 at expiration, which corresponds to an index stage of about 17,035.

Let’s say the Dow Jones plunged to 16,500 by expiration. The Diamonds could be buying and selling at $165, and the $175 places could be priced round $10, for a possible $5.35 revenue or 115% achieve in your put place.

DIA Lengthy Bull Name Unfold

• Technique: Lengthy Bull Name Unfold on the DJIA ETF (DIA)
• Rationale: Bullish on the Dow Jones, however wish to scale back premium paid
• Choices chosen: September $184 Name (lengthy) and September $188 Name (quick)
• Present Premium (bid/ask): 3.75 / $4.00 for $184 Name and $1.99 / $2.18 for $188 Name
• Most Danger: $2.01 (i.e., internet choice premium paid)
• Break-even: DIA value of $186.01 by choice expiry
• Most Reward: $4 (i.e., the distinction between the decision strike costs) much less internet premium paid of $2.01

The bull name unfold is a vertical unfold technique that includes initiating a protracted place on a name choice and a simultaneous quick place on a name choice with the identical expiration however at a better strike value. The target of this technique is to capitalize on a bullish view on the underlying safety, however at a decrease value than an outright lengthy name place. That is achieved by the premium obtained on the quick name place.

On this instance, the online premium paid is $2.01 (i.e., premium paid of $4 for the $184 lengthy name place much less the premium obtained of $1.99 on the quick name place). Be aware that you just pay the ask value if you purchase or go lengthy on an choice, and obtain the bid value if you promote or go quick on an choice.

Your break-even value on this instance is $186.01 (i.e., the strike value of $184 on the lengthy name + $2.01 in internet premium paid). If the Diamonds are buying and selling at say $187 by choice expiry, your gross achieve could be $3, and your internet achieve could be $0.99 or 49%.

The utmost gross achieve you’ll be able to anticipate to make on this name unfold is $4. Suppose the Diamonds are buying and selling at $190 by choice expiry. You’d have a achieve of $6 on the lengthy $184 name place, however a lack of $2 on the quick $188 name place, for an general achieve of $4. The online achieve on this case, after subtracting the $2.01 internet premium paid, is $1.99 or 99%.

The bull name unfold can considerably scale back the price of an choice place, however it additionally caps the potential reward.

DIA Lengthy Bear Put Unfold

• Technique: Lengthy Bear Put Unfold on the DJIA ETF (DIA)
• Rationale: Bearish on the Dow Jones, however wish to scale back premium paid
• Choices chosen: September $175 Put (lengthy) and September $173 Put (quick)
• Present Premium (bid/ask): $4.40 / $4.65 for $175 Put and $3.85 / $4.10 for $173 Put
• Most Danger: $0.80 (i.e., choice premium paid)
• Break-even: DIA value of $174.20 by choice expiry
• Most Reward: $2 (i.e., the distinction between the decision strike costs) much less internet premium paid of $0.80

The bear put unfold is a vertical unfold technique that includes initiating a protracted place on a put choice and a simultaneous quick place on a put choice with the identical expiration however a decrease strike value. The rationale for utilizing a bear put unfold is to provoke a bearish place at a decrease value, in change for a decrease potential achieve. The utmost danger on this instance is the same as the online premium paid of $0.80 (i.e., $4.65 premium paid for the lengthy $175 Put minus $3.85 premium obtained for the quick $173 Put). The utmost gross achieve is the same as the $2 distinction within the put strike costs, whereas the utmost internet achieve is $1.20 or 150%.

The Backside Line

Shopping for ETF choices on the DIA is a great technique to commerce the Dow Jones and could also be a superb different to buying and selling the ETF itself due to the considerably decrease capital necessities and technique flexibility afforded when buying and selling choices, so long as one is acquainted with the dangers concerned.