ETF Volatility Bets for DJIA 11,000 & Unemployment (DIA, SPY, VVX)

The Dow Jones Industrial Average was all set to see an 11,000 print this morning.  After the strongest September gains in most of our lives, the psychological level would have been a nice a capstone.  If, could have, yada yada yada… So far the 11,000 mark remains elusive and the highs of April over 11,300 will have to wait for now.  Today’s  range has been 10,936.39 as a low and 10,998.53 as a high.  The thing is that the market keeps whipping around and the volatility index, or the VIX, is still in a no-man’s land around 21.50. We do have a very key unemployment and non-Farm Payrolls data due Friday morning.  There is an election next month to boot.

We wanted to look at options trading strategies for how might be best to trade DJIA 11K…  A simple strategy came up, and without worrying about those weekly options.  The DJIA can be bought via the DIAMONDS or the SPDR Dow Jones Industrial Average (NYSE: DIA) ETF, and there is an options trade for that via a straddle.

The DIAMONDS trades at a slight premium or discount to the actual DJIA index, but the reality is that the target is one-tenth of the price of the actual DJIA at any given time.  The premium or discount depends upon many factors at any time, but how fast and how large of a move come together as the two key factors we watch.

DJIA 11,000 in theory equals $110.00 on the DIAMONDS, again more or less.  The point change on the DJIA index itself was nearly 200 points just on October 5 and the difference from the high to low on the day before was also close to 200 points despite a price change of less than 80 points.

When you get to benchmarks, many bet on the volatility rather than calling the directional move.  When you get asked, “Where will the DJIA be tomorrow?” is often easier to say “Different than today!” rather than guessing which way the wind will blow.

OCTOBER-2010 options expiration date is now only eight days out to October 15.  The largest open interest contracts in the DIAMONDS fall in the $105 to $110 strike prices in the puts and in the $106 to $113 strike prices in the Calls.

Earlier this morning there was a $110.00 OCT-2010 straddle opportunity when the DJIA hit a high of 10,998, but now the DJIA is right around the 10,950 level.  Why not take the $109 PUTS at $0.82 and the $110 CALLS at $0.79.  The open interest is large at more than 17,500 contracts for the calls and more than 10,500 for the puts.

Technically this is a strangle strategy rather than a straddle, but the long and short of it is that it is a synthetic straddle.  The $110.00 straddle costs a few cents over $2.00 in combined premium now that the DJIA has pulled back.  The key to remember here is that the break-even level on the straddle is 11,200 or 10,800, while the lower premium strangle of $1.61 would have to see the DJIA fall to under 10,739 or rise above 11,161 for the trade to pay off.

The S&P 500 index is not currently around as much of a key psychological level as the index is around 1,158.  The ETF there is the SPDR S&P 500 (NYSE: SPY), and it is far more liquid in trading volume than the DIAMONDS.  As far as the $115.80 price, the OCT-2010 options have a much higher open interest: the two closest out-of-the-money strikes in puts and calls for October each have more than 100,000 contracts in the open interest.

There are a dozen ways to skin a cat when it comes to options.  There is the CBOE Volatility Index, or the VIX; and there is even the iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX) exchange-traded note… and it has stock options as well.

It used to be that there was an ETF for everything.  Now there is an option for all the ETF strategies as well.  It might just be easier if Las Vegas had betting tables for higher and lower bets.  At least more people would know what to do.

JON C.OGG