Stocks & Commodities V. 31:12 (51): Explore Your Options by Tom Gentile

Stocks & Commodities V. 31:12 (51): Explore Your Options by Tom Gentile
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Explore Your Options by Tom Gentile

’Tis the season…to buy options With December now upon us, what’s a trader to do? As everyone starts planning their holiday parties, their vacations, and of course, their gift-buying, the market, too, is in planning mode. There are gifts from Father Wall Street for those who bear (no pun intended) to look for them. They come in the form of seasonality. Let’s take a look at a well-known seasonal pattern with an approach that’s an alternative to sticking your neck out with stocks or futures.


The Santa Claus rally was first observed by my friends at the Stock Trader’s Almanac. Yale Hirsch and his son Jeff came across the so-called seasonal week back in the 1970s. Jeff, who has taught at several of our seminars in the past, says the rally consists of the last five trading days of the year plus the first two following New Year’s Day. Don’t confuse this with the “January effect” — that’s a different seasonal pattern.

Jeff says that his father went back as far as 1950 with this Christmastime pattern and found that the S&P 500 averaged around 1.5% during that week. Not huge gains, but gains nonetheless. He goes on to tell me that this is mainly due to lower volume, general lack of news, and the pros buying into the end of the year. Let’s change this around a bit to look at options as an alternative way to invest in this seasonal pattern. To do so, we’ll look at last year’s Santa Claus rally and what alternatives there were to buying stocks, exchange traded funds (ETFs), or futures during that short time frame.

If you were to buy the SPX at the open of December 24, 2012 and get in at the closing price of 1426.66 and then sell the position on the close of January 3, 2013 at 1459.37, you would have a profit of 32.71, or a 2.2% gain. But what would happen if you were to trade options during this time frame? I analyzed two different positions using the January options on the following short-term trading strategies:

* Option 1 – Buying a January 1425 [atthe- money (ATM) call option] for 16.75 on the close of December 24, 2012. The cost and risk of this option is the debit. The cost is cheaper, but consists of pure time value, so you need this option to move in your direction.

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