Dow Jones ETF…Bring Me the Diamonds

The Dow Jones ETF is a nice and simple way to get exposure to the Dow Jones Industrial Average and can be traded or investing in on any online brokerage account.

While the Dow Jones ETF is a great trading vehicle, there are two other ways to mimic the average which include the Dow futures and the Dow Composite.

For the rest of this post, we will compare the Dow Jones ETF ($DIA) to the Dow futures (/YM) and the Dow Jones Composite ($DJX) and see which underlying is the best and most suitable for you.

The Dow Jones Industrial Average

The Dow Jones Industrial Average is an index that is a basket of 30 large cap (and mostly old) stocks that are meant to be a representation of the broader equity market.  Here are those 30 stocks that make up the Dow:

1. 3M
2. American Express
3. Apple
4. Boeing
5. Caterpillar
6. Chevron
7. Cisco
8. Coca-Cola
9. Disney
10. Dupont
11. Exxon Mobile
12. General Electric
13. Goldman Sachs
14. Home Depot
15. IBM
16. Intel
17. Johnson & Johnson
18. JPMorgan Chase
19. McDonald’s
20. Merck
21. Microsoft
22. Nike
23. Pfizer
24. Procter & Gamble
25. Travelers
26. United Technologies
27. UnitedHealth
28. Verizon
29. Visa
30. Wal-Mart

You can see this index has a little bit of everything, financials, consumer discretionary, energy, retail, technology, etc.  Again, this index is supposed to be a snapshot of the broader market and is represented by these 30 companies.  The idea of having exposure to the Dow is pretty simple.  Hold 30 stocks instead of one, reduce your risk (also limits your upside :)).  This way if Wal-Mart has a terrible day, you lose less having exposure to the index rather than being a shareholder of Wal-Mart.

This is a chart of the Dow over the last year.  Since the day after the election (November 9), the Dow has risen 15%.  Wow.

There are three immediate ways to get exposure to the Dow.  Let’s see which one if best for you!

Dow Futures (/YM)

The Dow futures are the futures contract for the Dow.  This contract is fairly large and trades from Sunday night to Friday afternoon during Globex hours.  Let’s see if this futures contract is the best way to get exposure to the Dow.

The Dow futures have a 5x index multiplier and every tick is worth $5.  This would make the notional value of the Dow futures 20890*5 or $104,450.  Not the biggest futures contract out there but still big.  You might be saying that isn’t so big.  Well right now with the current daily expected move, one can expect to gain or lose somewhere between up or down 142 ticks or $710.

There is a lot of liquidity in this product too.  The bid/ask spread on the future is never more than one tick wide and with 112,739 contracts traded today, a grand total of $11,775,588,550 exchanged hands on the Dow futures market.

That is pretty large.  Unfortunately, the Dow futures barely trade options which are crucial to being able to hedge our risk and give ourselves a better chance of making money.  We can see the bid/ask spread on the options is quite large and there is almost no volume and very little open interest.

We are going to take a pass on the Dow futures as the contract size is too large and the options market is non-existent.  Let’s see if trading the index is a better idea.

Dow Jones Industrial Average Index ($DJX)

There is a product with the symbol of $DJX that is trading the index itself.  Maybe this is a better idea?

Off the bat, we see a glaring issue here.  There was no volume today?

The reason for this is because this is purely a cash settled index so there is no stock to trade.  Cash settled means the options expire to cash rather than stock.  This is purely an aggregate of the 30 stocks mentioned above.  No stock to trade here folks.  While this is not a good sign, how are the options markets?

They aren’t the worst I have see and they are definitely a better option than the Dow futures.  The markets aren’t crazy wide however we feel like because of the lack of volume and open interest, it will be challenging to be filled at mid price here.  Because there is no stock to trade and the options markets really aren’t that great we are going to pass.  Let’s see if the Dow Jones ETF is any better.

Dow Jones ETF ($DIA)

Ah…the diamonds.  The Dow Jones ETF.  Maybe this will be better?

How about liquidity in the stock…what do we see?

Having a bid/ask spread $.02 wide is pretty much the best you can get.  Very tight markets mean a lot of competition for order flow.  An excellent sign of institutional interest.

The Dow Jones ETF $DIA also traded 2,740,993 shares today.  That absolutely passes our test of stock volume as the total notional value traded today for the diamonds was $574,128,393.78.

What about options? The Dow futures have excellent liquidity for the contract but had no options activity.  What about the Dow Jones ETF?

HELLO!  🙂  This is fantastic as that much volume in the options market screams liquidity and institutional interest.  The total notional value traded on the options market today in the diamonds was $712,708,596.  Damn!

But are the options markets as tight and liquid as the stock?

Oh, you bet! This was a live shot taken during the trading day to show the true width of the options markets.  Three pennies wide out of the money at the most as well as open interest in the thousands.  The Dow Jones ETF $DIA is a winner.

The Final Verdict on the Dow

Want exposure to the Dow?  The futures are too big and don’t trade options.  The index doesn’t trade stock.  But the diamonds, the ETF version of the Dow…well they have super tight markets, a ton of liquidity, and the capability for you to do what you want, whenever you want.  $DIA’s are the winner!