It's an old theory with a timeless lesson—and lately, it's been telling us that this rally is strong.
Dow Theory, developed by Charles H. Dow himself in the late 1800s, holds that the strength of a rally can be determined by the relative strength of stock indexes. The theory is that the Dow Transports should lead a rally in the Dow Jones industrial average, since an improving manufacturing sector would require additional shipping volume, whether via boat, train or air.
More than 100 years later, this is still a valid theory that is closely followed by many traders. Last week, we saw the Dow Transports and the Dow Industrials close at new 52-week highs, which has one option trader concluding that this rally will continue.
One of the top weightings in the Dow transportation average is Union Pacific, and on Monday morning, someone bought 100 August 160-strike calls for $2.95 with the stock at $152.83. This is $29,500 bet that UNP will be above $162.50, or 6.3 percent higher, by August expiration.