Dow Jones Index Stocks - A Preferred Option Trading Choice

FinanceTrading / Investing

  • Author Owen Trimball
  • Published June 15, 2010
  • Word count 601

If you're an option trader and your main objective is to be able to quickly and efficiently create option positions with high 'open interest' and therefore great liquidity, then the underlying stocks that make up the Dow Jones Index might be just right for you.

The Dow Jones Industrial Index (DJIA) is made up of 30 large companies based in the USA. They all have options, so all you need to do is find a list of the DOW30 together with their stock symbols and create a watchlist in your charting package or broker account. Once you have that, simply analyze these price charts on a daily basis, looking for familiar patterns that to you, mean trading signals according to whatever criteria you use.

Because the Dow Jones stock are so highly traded, you can not only do simply buys of call and put options, but is is also much easier to create advanced options positions such as condors, butterfly, calendar and ratio spreads. These involve a combination of long and short positions which can involve a wide spread of strike prices. The DOW 30 is one place where you shouldn't have any trouble locating "way out of the money" option strikes which still have great open interest.

Some option trading educators adopt the policy that it is a good idea to have a limited number of stocks that you follow anyway. The idea is that you 'get to know' these stocks intimately and become familiar with the way they trade. They become your trading 'friends' and you know which signals are the most reliable for each of them. Thirty stocks is a good sized watchlist for anyone, so you should have no problem finding enough trades.

You can use the Dow 30 stock for range trading strategies, delta neutral strategies, as well as vertical spreads, calendar spreads and ratio spreads.

It's important that whatever option software you are using to trade these options, has the capability to give you the current implied volatility (IV) in the option premium compared to the historical volatility (HV) of the underlying stock. Due to the high ebb and flow of demand for Dow 30 stocks, their option prices can sometimes be overpriced or underpriced. This is critical information that you need to know, particularly if you're considering using spreads or straddles.

Straddle options should always have low implied volatility and therefore be underpriced. You want them cheap so that if the stock price explodes, the increase in implied volatility in the option premiums that often comes with increased buying or selling volumes will add to your potential profit.

For spread positions, you should prefer higher IV on the short (sold) leg of the position compared to the IV for the long (bought) leg. This will give you an edge, particularly if the stock doesn't move in your anticipated direction. It isn't a problem if the IV is the same, but you definitely want to avoid spreads where the IV of the long position is greater than that of the short leg.

The Dow 30 stocks tend to trade in predictable patterns which produce reliable indicators and therefore, can be stocks of choice for better trading results.

If you decide to adopt these large US companies as your option trading friends, you should look for a reputable broker based in the USA that allows you to easily fund and withdraw from, your account from anywhere in the world. Set up your watchlist, wait patiently for the right entry signals, stick to your plan, manage your trading capital carefully and there is no reason why you shouldn't realize some consistent cashflow.

Owen has traded options for many years. Visit his popular site to discover the advantages of Option Trading and how strategies like Dow Jones Option Trading can provide a regular income without the need for large trading capital.

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Article comments

Surrey Dentist
Surrey Dentist · 14 years ago
It was a very nice article and it will help me in advancing in the stock market! Thanks!

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