Trading the INDEXDJX:DJI (Dow)…this should be fun and a nice addition to our ultimate guides to trading the INDEXSP:.INX (S&P 500) and the INDEXNASDAQ:.IXIC. We all know the Dow…it’s the one that gets talked about every single day on the likes of CNBC and Bloomberg. The INDEXDJX:DJI (Dow) was created by Charles H. Dow (who was also a founder of the Wall Street Journal) back in 1898 to serve as a benchmark for the greater US stock market. At that time, 12 companies were added to the Dow with only General Electric still a member of the group of now 30 stocks. Here is a list of the 30 stocks there today:
|Johnson & Johnson||$JNJ|
|Proctor & Gamble||$PG|
One thing to note about the INDEXDJX:DJI (Dow) is that it is no longer the benchmark that everyone compares their performance. That has been replaced by the INDEXSP:.INX (S&P 500) as the S&P is a much larger basket of stocks (500) and incorporates a wider variety of growth companies.
Nevertheless, people still would like exposure to a handful of the names listed above that are currently in the INDEXDJX:DJI (Dow). There are a few ways to get direct exposure to the index which include the Dow futures, the Dow index, and the Dow ETF. We are going to spend the rest of this article going through these three options to see which INDEXDJX:DJI (Dow) product is right for you.
The INDEXDJX:DJI (Dow)
While the Dow is not the most watched index any longer, there is still validity in trying to get immediate exposure to the index as the chart above shows how “diversified” the index is. Also, many investors grew up with the Dow being the end all be all so they still want to get involved. Let’s dive in and really look hard through all of our options in trading the INDEXDJX:DJI (Dow) to see which is best for you.
The Dow futures, like all futures, trade 24/5 on the Globex exchange and are quite large products and attract an incredible amount of liquidity. To showcase the level of participation and liquidity, let’s take a look at the difference between what someone wants to buy for versus what someone wants to sell for. We call this the bid/ask spread.
We can see there is 1 point between the bid and the ask which represents just one tick (the smallest distance between two price points). There is clearly a lot of competitions for futures contracts here. Every tick in the Dow futures is worth $5 and with a price of $20864, the Dow futures have a notional value of $104,320. To make things even better for the cowboys amongst us, we only need to provide $4,400 in margin in order to trade one contract. That’s a little over 23:1 leverage.
But we said people participate heavily in this contract and the way we can see that is by having a one tick wide bid/ask spread. Today, 104,338 contracts exchanged hands which is a total notional value of over ten billion dollars or $10,884,540,160.
Since this is the case, we expect their options markets to be as competitive as the bid/ask spread for the contract. Let’s see what the options markets look like here. How do the bid/ask spreads in the options markets look?
Wide. Too wide. We would expect those to be much tighter than 15 ticks ($75). This is not looking good. But maybe there is a bunch of volume here?
Whomp whomp. Nothing to see here. This makes more sense now as to why the options bid/ask spreads were so wide. It’s because there is no competition here for options on these Dow futures.
And sure enough, there is barely any respectable level of open interest.
Nothing. And to make matters worse, there are barely any tradable options expirations.
THE NEXT EXPIRATION IS 88 DAYS FROM NOW ARE YOU JOKING???
The Dow futures themselves are not a bad replacement for trading the INDEXDJX:DJI (Dow). However, we never trade anything unless we can improve our positions through the options market. Because the options market in the Dow futures are weak, we do not recommend trading the Dow futures as a substitute for trading the INDEXDJX:DJI (Dow).
Our next hope is the Dow Jones Industrial Average Index $DJX.
Dow Jones Industrial Average Index $DJX
Like the $SPX and the $NDX, the $DJX is a cash settled index. When we speak about anything settling, we are speaking about options and what they settle to. These broad-based equity indexes do not have stock to trade
thus, all options settle to cash rather than stock. Since we know that there is no stock to trade here, we can go ahead and say the stock is not liquid at all.
But since this is the Dow index and is one of the three potential replacements for getting direct exposure to the INDEXDJX:DJI (Dow) I’m sure their options markets are great…right?
Let’s start from the top.
This is not a great number. And because this index settles to cash, the total notional value traded here today was $578,050.90 ($209.06*2765). This is a very low number for any tradable asset let alone the index for the Dow Jones Industrial Average.
Maybe they have tight bid/ask spreads? If they did, this would be a sign of competition for orders.
These are not too bad. Ten cents wide is much better than the Dow future for sure. And since there is a nice tax advantage to trading the indexes, we have to say they aren’t too bad at all.
Are there at least a lot of expiration cycles?
Nope. They only have one weekly posted right now and the rest are the normal monthly options that everyone gets out of the box.
Are there at least institutions that trade this? If institutions are involved here with the $DJX, we would see open interest in the thousands for the strikes nearest to the current price of the index.
We do not.
After seeing no stock volume and very little activity and competition in the options market, we can go ahead and say that the Dow Jones Industrial Average Index $DJX is also not a respectable replacement for getting direct exposure to the INDEXDJX:DJI (Dow).
Two down, one to go, and we have not found a suitable replacement to trade the INDEXDJX:DJI (Dow) yet.
SPDR Dow Jones Industrial Average ETF Trust
Diamonds, baby. Let me introduce you to the Dow ETF, $DIA. This is our last hope in getting direct exposure to INDEXDJX:DJI (Dow) with a liquid and fair product where there is participation in the markets.
Just like the futures and the index, let’s start with volume. What does the bid/ask spread look like here?
We can see here that the bid/ask spread is one penny wide. This shows us that there is serious participation for $DIA stock. How many shares traded today?
We can work with that. Anything in the millions is good by us. This volume represents a total notional value of $691,325,910.45 worth of stock.
$DIA stock checks out and passes our test meaning the stock is very tradable. But remember, we don’t trade anything unless the options markets are active and competitive. Let’s star with options volume first.
This is certainly a step in the right direction. The size of this ETF’s options market today was $319,421,865.
What about the bid/ask spreads? Surely with that much options volume, they must be competitive. We should see them no wider than a few pennies apart.
There we go! Nothing wider than four cents here. This is an example of the competitive, fair, and liquid options market we have been looking for. What about institutional interest? Do we see open interest in the thousands?
This isn’t the best open interest every but it passes.
Now…what about multiple expiration cycles. Remember, every stock gets monthly expirations but only those with extra demand get weeklies. What do the Diamonds have?
They have weeklys, quarterlys, and monthlys…because the market demand was great enough for them.
Because of all the reasons and more, we can say that the DIA ETF is the best replacement for getting direct exposure to the INDEXDJX:DJI (Dow).
Wrapping up our Friend Mr. indexdjx:dji
Remember, we originally wanted to get exposure to the INDEXDJX:DJI (Dow) because we liked the index or we liked the diversification it provides or we like a handful of the names currently in the index.
But in order to do that, we have to find a very liquid product for us to trade and invest. This would have to be a product that has competition and liquidity.
We looked at the Dow futures, the Dow index, and the Dow ETF. Here is what we found.
After all of this, we can say…
Want exposure to the INDEXDJX:DJI (Dow)? Trade and invest in the Dow Jones ETF, $DIA.
Now come check out how far this index can move over the next year!