With the Dow continuing to make new all-time highs we continue to hear the bears say we’re technically overbought, the market has to correct, and that investors should be rushing to buy protection with volatility at the lowest levels we’ve seen in more than five years. Many are calling this muted bull run the “unloved rally,” with retail investors yet to fully rotate out of fixed income and other safe haven assets. The Dow has seen nine straight days of gains for the first time in 16 years, and is shooting for the 10th straight day of gains today. Is this the sign that we are overbought, or will this bring in all of the sideline money and send us for a leg higher?
The problem is nobody really benchmarks their performance to the Dow. Most traders would feel a lot more confident in the bull market run if we were looking at the S&P 500 hitting new all-time highs on a daily basis. Even with the debt ceiling looming, and the effects of the sequester yet to be fully realized, the market continues to march higher. The VIX, commonly known as the “fear index,” is trading at multi-year lows. This tells us two things. The market is not concerned with the uncertainty in Washington, and that premium is cheap. This means that a trader can set up an options trade with a great risk vs. reward setup.
So if a trader wanted to speculate on further upside in the Dow there are a few ways they can do it.
- Buy the individual Dow components. Although this would be very capital intensive, it would allow a trader to leg out some of the laggards or losers in the index. Even though the index is at an all-time higher, there are components that have been underperforming.
- Buy the ETF. The SPDR Dow Jones Industrial Average ETF (DIA). Although this would also be capital intensive, this is an easy position to manage.
- Dow Futures and Options on Futures. Tracks the performance of the Dow very well, and is one of the cleanest trading futures contracts. Using an options play would also let a trader set up a great risk vs. reward trade.
The 14,450 April straddle in the Dow is currently priced at around 330 points. With Dow futures trading at 14,440 this gives us an implied upside target near 14,470 by April expiration. With this in mind we can look at a possible bullish trade setup.
Trade: Buying the YM Apr 14700-14800 Call Spread for 25 points
Risk: $125 per 1 lot
Reward: $375 per 1 lot
This trade lets a trader take some upside speculation with a great reward potential, small capital outlay, and well defined risk.
Click to enlarge.