The Safer Way to Bet on More Dow Gains

Have money to invest, but don't want to lose your shirt in a correction? Consider this investing strategy.

Feb 26, 2014 at 4:30PM

For five straight years, the Dow Jones Industrials (DJINDICES:^DJI) have posted substantial gains, recovering from the extensive damage that the 2008 recession and market meltdown did to the economy and the stock market. Yet, now that many investors have finally gotten comfortable with the idea of investing in stocks again, contrarian investors worry that an influx of new investors into the stock market could bring the Dow's five-year bull market to an end.

Fortunately, there's a way to take positions in the Dow Jones Industrials without assuming the full risk of owning the stocks themselves. By using a strategy involving options, you can profit if the Dow keeps rising, while limiting your downside risk if January's Dow correction turns into a more extensive pullback.

Using call options
Many investors avoid options because of their reputation as a highly risky investment. It's true that options often involve the risk of complete loss, and when used improperly, options strategies can wreak havoc over unsuspecting investors' portfolios.

But when you want to limit your losses while still participating in further moves upward, either for a stock index like the Dow or for individual stocks, then simple strategies involving buying call options can be a great way to accomplish your task.

For instance, say that with the Dow at around 16,200, you expect the average to keep rising between now and midyear. You could buy a June 160 call option on the Dow Micro index, which is equal to 1% of the value of the Dow. Currently, such an option would cost you about $550.

If the Dow does rise between now and mid-June, then the option will be worth the number of dollars by which the Dow's closing value exceeds 16,000. So if the Dow jumps to 17,000 by June, then your option will be worth $1,000, and you'll book a $450 profit.

At the same time, though, your risk under the option is limited to the $550 you paid for it. Whether the Dow drops to 16,000, 15,000, or 5,000, your loss is the same $550. When you compare that to the thousands of dollars you would lose by buying enough shares of the SPDR Dow Jones Industrials ETF (NYSEMKT:DIA) to match the upside potential of the option position, you can see the risk advantage that options can carry.

Explore options
Where people get into trouble with options is when they think that they should take advantage of the leverage that options make possible. For instance, if you wanted to make a leveraged bet on the Dow, you could get almost 30 times more upside exposure by buying 30 June 160 calls on the Dow micro than you would buy spending the same amount of money on 100 shares of the SPDR Dow ETF. At the same time, your risk of losing the entire $16,000 to $17,000 you'd spend on each respective position would be much higher with the options strategy.

Get invested
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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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