How to Trade the Dow Via Options

The "Dow" refers to the Dow Jones Industrial Average, the oldest and most widely followed U.S. stock market index. Index options can be a low-cost way to make directional trades on the future value of the Dow. Options are contracts with a short term lifespan that provide both a downside risk for a trader and the possibility of very large profits.

• 1

  Open an online brokerage account with option trading authorization. Option trading requires additional disclosure and authorization to a regular stock brokerage account. The level of trading authorization is based on the trader's previous experience. A level 2 -- out of 5 -- is required to buy calls or puts. Level 3 authorization is required for spread trading. The Barron's 2010 Broker Survey rates thinkorswim, TradeMonster and MB Trading as the top brokers for option trading.

• 2

  Set up charting and technical analysis screens using broker provided tools to analyze the value of the Dow. The symbol DJX is the underlying index for Dow options and is worth 1/100 the value of the Dow Jones index. For example, if the Dow is at 11,169, DJX is at 111.69. Each point move for DJX equals a 100 point move for the Dow. Traders use technical indicators to predict trends and reversals in a particular security value.

• 3

  Buy call options on DJX if you predict the Dow will go up in value or put options if you are forecasting a drop in the value of the Dow Jones. The option chain for DJX in your brokerage screen will show all of the put and call options trading against the Dow. Strike prices are set in one point--100 Dow points--increments, and expiration dates are available for the next four months, then quarterly.

• 4

  Monitor the value of the Dow and close out your positions when it hits your target price. Positions are closed by placing a sell trade for the option contracts in your account. A DJX option can also be allowed to expire on the expiration date and you will receive any option value profits into your account or it will expire worthless if you predicted wrong for the Dow.