- Dow Jones Industrial Average Index Options
- How to Trade DJIA Index Options
- Example: Buy DJX Call Option (A Bullish Strategy)
- Continue Reading...
- Limited Downside Risk
- Tackle Trading Halftime Report Jan 15th 2019
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- Writing Puts to Purchase Stocks
- What are Binary Options and How to Trade Them?
- Investing in Growth Stocks using LEAPSÂ® options
- Effect of Dividends on Option Pricing
- Bull Call Spread: An Alternative to the Covered Call
- Dividend Capture using Covered Calls
- Nadex is designed for day trading stock indices like the Dow®
- Leverage using Calls, Not Margin Calls
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- What is the Put Call Ratio and How to Use It
- Understanding Put-Call Parity
- Understanding the Greeks
- Valuing Common Stock using Discounted Cash Flow Analysis
Home / Index Option Trading
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.
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.
|Proceeds from Option Exercise||=||Cash Settlement Amount|
|=||(Index Settlement Value - Option Strike Price) x Contract Size|
|=||(89.43 - 78.00) x $100|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Proceeds from Option Exercise - Investment|
|=||$1,142.61 - $518.00|
|Return on Investment||=||Net Profit / Investment|
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.
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.
Tackle Trading Halftime Report Jan 15th 2019
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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