Dow Jones Industrial Average Index Options

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Dow Jones Industrial Average

Dow Jones Global: DJIA

Apr 9, 2020, 12:37 p.m.

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    Dow Jones Industrial Average Index Options

    DJIA index options are option contracts in which the underlying value is based on the level of the Dow Jones Industrial Average, a price-weight stock market index calculated from the stock prices of 30 of the largest and most widely held public companies in the United States representing the most important industries.

    The Dow Jones Industrial Average index option contract has an underlying value that is equal to 1/100th of the level of the DJIA index. The Dow Jones Industrial Average index option trades under the symbol of DJX and has a contract multiplier of $100.

    The DJX index option is an european style option and may only be exercised on the last business day before expiration.

    Product Name Symbol Underlying Value Contract Multiplier Exercise Style
    Dow Jones Industrial Average Options DJX 1/100th of DJIA $100
    (Full Contract Specs)
    European
    Jumbo-DJX Options DJL 1/10th of DJIA $100
    (Full Contract Specs)
    European

    How to Trade DJIA Index Options

    If you are bullish on the DJIA, you can profit from a rise in its value by buying Dow Jones Industrial Average (DJX) call options. On the other hand, if you believe that the DJIA index is poised to fall, then DJX put options should be purchased instead.

    The following example depict a scenario where you buy a near-money DJX call option in anticipation of a rise in the level of the DJIA index. Note that for simplicity’s sake, transaction costs have not been included in the calculations.

    Example: Buy DJX Call Option (A Bullish Strategy)

    You observed that the current level of the DJIA index is 7,776.18. The DJX is based on 1/100th of the underlying DJIA index and therefore trades at 77.76. A near-month DJX call option with a nearby strike price of 78 is being priced at $5.18. With a contract multiplier of $100.00, the premium you need to pay to own the call option is thus $518.00.

    Assuming that by option expiration day, the level of the underlying DJIA index has risen by 15% to 8,942.61 and correspondingly, the DJX is now trading at 89.43 since it is based on 1/100th of the underlying DJIA index. With the DJX now significantly higher than the option strike price, your call option is now in the money. By exercising your call option, you will receive a cash settlement amount that is computed using the following formula:

    Cash Settlement Amount = (Difference between Index Settlement Value and the Strike Price) x Contract Multiplier

    So you will receive (89.43 – 78.00) x $100 = $1,142.61 from the option exercise. Deducting the initial premium of $518.00 you paid to buy the call option, your net profit from the long call strategy will come to $624.61.

    Profit on Long DJX 78 Call Option When DJIA at 8,942.61
    Proceeds from Option Exercise = Cash Settlement Amount
    = (Index Settlement Value – Option Strike Price) x Contract Size
    = (89.43 – 78.00) x $100
    = $1,142.61
    Investment = Initial Premium Paid
    = $518.00
    Net Profit = Proceeds from Option Exercise – Investment
    = $1,142.61 – $518.00
    = $624.61
    Return on Investment = Net Profit / Investment
    = 121%

    In practice, it is usually not necessary to exercise the index call option to take profit. You can close out the position by selling the DJX call option in the options market. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.

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    In the example above, as the option sale is performed on expiration day, there is virtually no time value left. The amount you will receive from the DJX option sale will still be equal to it’s intrinsic value.

    Limited Downside Risk

    One notable advantage of the long Dow Jones Industrial Average call strategy is that the maximum possible loss is limited and is equal to the amount paid to purchase the DJX call option.

    Suppose the DJIA index had dropped by 15% instead, pushing the DJX down to 66.10, which is way below the option strike price of 78. Now, in this scenario, it would not make any sense at all to exercise the call option as it will result in additional loss. Fortunately, you are holding an option contract, and not a futures contract, and so you are not obliged to anyway. You can just let the option expire worthless and your total loss will simply be the call option premium of $518.00.

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    How To Buy Options On the Dow Jones

    The easiest and most cost-effective avenue to trade the Dow Jones Industrial Average (DJIA) is through an exchange-traded fund (ETF) (See: Understanding and Playing the Dow Jones Industrial Average). One of the oldest ETFs is the SPDR Dow Jones Industrial Average ETF Trust (DIA), which tracks the DJIA and seeks to provide investment results that correspond to the price and yield performance of the index. As each DIA unit trades at approximately 1/100 th the prevailing level of the Dow Jones Industrial Average, trading the DIA requires a substantial capital outlay. If you have limited capital but want to trade the index, options on the “Diamonds” – the colloquial term for the DJIA ETF – might be a good way to go, assuming you know the risks involved in option trading. We demonstrate how to buy options on the DJIA in the following sections.

    Types of Option Strategies

    For the purposes of this exercise, we focus on the September 2020 options – which expired on September 18, 2020 – on the Diamonds. This expiration date came less than one month after the August 2020 “mini flash crash”. That event lifted CBOE Market Volatility Index (VIX) above 50 for the first time since 2020, impacting pricing on the September contracts. (For tips on how to select the right option, see Pick the Right Options to Trade in Six Steps.)

    The emphasis here is on buying (or going “long”) options, so that your risk is limited to the premium paid for the options, rather than strategies that involve writing (or going “short”) options. Specifically, we focus on the following option strategies:

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    Note that these examples do not take into account trading commissions, which can significantly add to the cost of a trade.

    Long Call on the DIA

    Strategy: Long Call on the DJIA ETF (DIA)

    Rationale: Bullish on the underlying index (DJIA)

    Option selected: September $183 Call

    Current Price (bid/ask): 3.75 / $4.00

    Maximum Risk: $4.00 (i.e., option premium paid)

    Break-even: DIA price of $187 by option expiry

    Potential Reward: (Prevailing DIA price – break-even price of $187)

    Maximum Reward: Unlimited

    You would buy or initiate a long position on a call if you were bullish on the underlying security. The all-time high on the DIA units at that time was $182.68, which was reached on March 2, 2020, the same day that the DJIA index peaked at 18,288.63. A strike price of $183 means that you would be looking for the DJIA to surge past its March 2020 high by the September 18, 2020 expiration of the calls.

    If the DIA units close below $183 – which corresponds to a Dow Jones level of about 18,300 – by option expiry, you would lose the premium of $4 that you paid for the calls. Your break-even price on this option position is $187 (i.e., the strike price of $183 + $4 premium paid). What this means is that if the Diamonds close exactly at $187 on September 18, the calls would be trading at $4, which is the price that you paid for them. Assuming you sell them at $4 (just before the close of trading on September 18), you would recoup the $4 premium paid when you bought the calls, and your only cost would be the commissions paid to open and close the option position.

    Beyond the break-even point of $187, the potential profit is theoretically unlimited. IIf the Dow Jones soared to 20,000 before expiration, the DIA units would be trading at about $200. Your $183 call would be trading at around $17, for a tidy $13 profit or 325% gain on your call position.

    Long Put on the DIA

    Strategy: Long Put on the DJIA ETF (DIA)

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