A Time for Crude and a Time, um, Not for Crude?

I like to think of myself as a creative, independent thinker.  Of course I’d also like to think of myself as handsome, charming and witty and look how that’s worked out.  But I digress.  Anyway, on my Twitter feed last week I posted a link to a piece from Stock Trader’ Almanac regarding a terrific seasonal trend in crude oil. Let’s take a closer look at what the boy’s at the Stock Trader’s Almanac lab uncovered.

The Stock Trader’s Almanac Crude Oil Seasonal Trend

The seasonal trend highlighted in the link to STA points out the fact that crude oil trends to be bullish for 60 trading days starting on February 13th (or the closest trading day to it).  As we will see in a moment, the results are compelling.  What is even more interesting is to compare the results generated by holding a long position in crude oil (or a crude oil ETF) during this time period to the results generated by holding a long position in crude oil all of the rest of the year.

The Test

For the record, the historical data that I use for crude oil futures is based on  a “continuous contract” (which basically strings together the daily price change for the currently most active contract at any given point in time), so they may not exactly reflect what a real trader might have experienced in real-time trading.  But they will be close.  And the point of this exercise is not really the “raw” returns but the “relative” returns of the “bullish” period versus “all other” periods.

So for our test:

*Bullish Period

Starts at the close of trading on the last trading day prior to February 13th each year, and lasts for 60 trading days.

*Bearish Period

Starts at the end of the 60 day period described above and lasts until the close of trading on the last trading day prior to February 13th the next year.

The Results

Figure 1 displays the growth of equity achieved by holding a long position in crude oil futures (a $1 move in the price of crude oil equals $1,000 change in the value of the futures contract) during the bullish period (blue line) versus holding a long position in crude oil futures during the bearish period (red line) since April 5th, 1983 (when crude oil futures starting trading).cl 1Figure 1 – $ +(-) for crude during bullish period (blue line) versus bearish period (red line); 4/5/1983 through 1/16/2014

For the record:

-During the “bullish” period crude oil futures gained roughly +$106,000.

-During the “bearish” period crude oil futures lost roughly (-$88,000)

Using ETFs instead of Futures

While the numbers above are compelling, let’s be honest, the vast majority of traders will never trade a crude oil futures contract (and in reality that is probably a good thing given the dollars and risks involved).  So what about using an ETF that tracks the price of crude oil?

The most heavily traded crude oil ETF is ticker USO.  Now I don’t wish to go into details but USO has had some – how shall I say this, um, performance issues – due to the way its portfolio is configured (i.e., it holds several months of futures contracts however, due to “contango” – whereby the farther out contracts trade at a higher price than the closer months – its share price has tended to lag the price of crude oil, particularly in up markets and, oh never mind.  If you want to know more Google “contango and uso”).

Still, the results generated by this seasonal trend via USO are pretty compelling. Figure 2 displays the growth of $1,000 fully invested in USO only during the bullish seasonal period (blue line) versus $1,000 fully invested in USO only during the bearish seasonal period (red line) since USO started trading on 4/10/2006.cl 2Figure 2 – Growth of $1,000 invested in ETF ticker USO during bullish period (blue line) versus bearish period (red line); 4/10/2006 through 1/16/2014

For the record:

-During the “bullish” period, $1,000 in USO grew to $1,861 (+86.1%)

-During the “bearish” period, $1,000 in USO declined to $146 (-85.4%)

These types of stark contrasts are what we “quantitative analyst types” refer to as “statistically significant.”

Summary

So does it make sense to simply buy and hold crude oil futures during the bullish period and to sell short during the bearish periods? Probably not.  For the record I am not advocating this as a standalone strategy. A closer look at Figures 1 and 2 reminds us that large unexpected moves can and will happen regardless of what the “seasonals” are suggesting “should” happen.  And as always, there is never any guarantee that the bullish phase will see higher prices nor that the bearish phase will see lower prices.

Probably a better way to use this information is to given the bullish case the benefit of the doubt during the bullish phase and vice versa.  To wit, should crude oil show signs of bottoming out and/or attempting to rally starting around mid-February, aggressive traders might do well to look for ways to play the bullish side.

Thanks Stock Trader’s Almanac!

Jay Kaeppel

An Update on “If You Just Have to Pick a Bottom in Crude Oil”

NOTE: If you have no interest whatsoever in option trading you are free to stop reading right now.  Still, if you are interested in trading strategies that can make money in unusual circumstances you might consider plowing forward for at least a few more paragraphs.

On December 16, 2014 I published an article titled “If You Just Have to Pick a Bottom in Crude Oil”.  For the record, I was not necessarily advocating doing so; the real point was to highlight a little known option trading strategy known as the “Reverse Calendar spread.”  The reverse calendar spread is a strategy that should only be used when implied option volatility for the security in question is extremely high, because the primary way that this trade can make money is if implied volatility subsequently falls sharply.  So let’s review the hypothetical trade I highlighted and then update to see where things stand at the moment.

The Original Trade

The original trade involved the following:

*Buy 1 Feb 2015 21 Call @ 1.46

*Sell 1 Mar 2015 21 Call @ 1.77

The prospects for this trade as of 12/16/14 appear in Figures 1 and 2.

cl f4

Figure 1 – Reverse call calendar spread for USO (Courtesy: www.OptionsAnalysis.com)

cl f5Figure 2 – Reverse call calendar spread for USO (Courtesy: www.OptionsAnalysis.com)

The goal was to exit the trade by 2/6/15 to eliminate the risk of experiencing the maximum loss depicted by the black risk curve line in Figure 2.

So Where are We Now?

As of 12/16/14

*USO trading at 21.30

*Feb 21 Call trading at 1.46 with implied volatility of 51.60

*Mar 21 Call trading at 1.77 with implied volatility of 42.60

As of 1/13/15

*USO trading at 17.46

*Feb 21 Call trading at 0.17 with implied volatility of 49.5

*Mar 21 Call trading at 0.37 with implied volatility of 45.9

The current status of the trade (with a targeted “exit no later than” date of 2/6/15) appears in Figures 3 and 4.jotm20150113-4Figure 3 – Current status of USO Reverse Calendar spread (Courtesy: www.OptionsAnalysis.com)jotm20150113-5Figure 4 – Current status of USO Reverse Calendar spread (Courtesy: www.OptionsAnalysis.com)

As you can see, implied volatility has actually gone in the “wrong direction” on both legs (the Feb call we bought saw a slight decline in IV while the Feb call we sold saw a slight rise in IV).

However, during the same time USO has plummeted 18% from 21.30 to 17.46 a share and in the process pushed the trade below the lower breakeven point.  With an approximate maximum risk of roughly $750 (not shown in any of the graphs and can only occur if trade is held until February option expiration on 2/20/15 – which is why we have targeted 2/6/15 as the “exit by” date), the open profit of $110 represents just less than a 15% return.

Not bad for a trade that was put on (hypothetically speaking) in anticipation of:

A) A sharp upside reversal by USO, and/or

B) A sharp decline in option implied volatility.

Despite the fact that neither of these things occurred the trade is showing a profit.

Summary

It bears repeating that this is a hypothetical trade (dang).  But like I said at the outset, sometimes it’s good to know how to use certain strategies that can make money in unusual circumstances.

The reverse calendar spread certainly falls into this category.

Jay Kaeppel

 

Great Days for Real Estate

This title implies that perhaps I am talking about the fact that real estate stocks have been performing quite well of late.  As you can see in Figure 1, since bottoming in December 2013, the most heavily traded real estate ETF – ticker IYR – is up over 25%.  And that is a good thing.iyr bar chartFigure 1 – Real Estate ETF Ticker IYR (Courtesy: AIQ TradingExpert)

But the most recent rally is not what I am talking about.  I am referring more to what goes on “under the hood.”

As you may know if you (WARNING: Shameless Self-Serving Plug to follow) read my book “Seasonal Stock Market Trends”, I have a “thing” for seasonality in the financial markets.  And I also understand that this is also not everyone’s “cup of tea.”  Depending on one’s point of view seasonal trends can either be considered to be

a) Interesting and potentially useful, OR;

b) Data curve-fitting to the nth degree

Personally I choose a), but you may choose b).  And that’s OK because if we reach the point where we all trade and invest the same then there won’t be anybody left to take the other side of our trades.

The Gist of Seasonal Trends

For the record, the underlying reason that I look at seasonal trends is to attempt to find an “edge.”  I would guess that 90% of traders and investors look at fundamental and/or technical analysis.  I would guess that no more than 10% of traders and investors look at seasonal trends.  So my rhetorical question of the day is:

If you are looking for an edge in the markets does it make sense to look:

a) Where everyone else is looking, OR;

b) Where hardly anyone else is looking?

Again, the choice is yours.

The Best Days for Real Estate

For the following illustration of using seasonal trends we will use ticker REPIX, which is the Profunds Real Estate mutual fund.  For the record, this fund uses leverage of 1.5-to-1.  For those who want less risk – and are willing to settle for less return – there is the Rydex real estate mutual fund (ticker RYRIX) and many real estate ETFs – with ticker IYR being the most heavily traded.

The Strategy – We will hold ticker REPIX on the following trading days each month:

*The first two trading days of the month

*Trading day’s #8, 12 and 15

*The last four trading days of the month

Obviously this particular strategy is only for traders who are “hands on” and willing to hold positions for either 1 day (in the case of trading days 8, 12 and 15) or 6 days (the four end of month days plus the two start of the next month days).  Once again, this is obviously not everyone’s “cup of tea.”  Still, the results are fairly compelling.

Figure 2 displays the growth of $1,000 invested in ticker REPIX only during the days listed above starting on the August 8, 2000 (when REPIX started trading).repix 1Figure 2 – Growth of $1,000 invested in REPIX during “Best Days” (Aug 2000-present)

For the record, $1,000 invested this way grew to $25,694.  Now some people will look at the return and say “hmm, that look pretty good.”  Others will look at the chart itself and say “Wow, that looks way to volatile.” But looking at a set of returns in a vacuum makes it hard to really judge things.

So to get a better feel for things, let’s compare the performance in Figure 2 to that of the S&P 500.  In Figure 2 the blue line represent the growth of $1,000 invested in REPIX as described above while the red line represents the growth of $1,000 invested in ticker SPY on a buy-and-hold basis over the same time period.

repix 2Figure 3 – Growth of $1,000 invested in REPIX only on “Best Days” (blue line) versus SPY (red line) (Aug 2000-present)

For the record, $1,000 invested in REPIX during seasonally favorable days grew to $25,694 (+2,469%) while $1,000 invested in ticker SPY on a buy-and-hold basis grew to $1,390 (+39%).

One last comparison to make is to compare the performance of REPI on “seasonally favorable” days versus “all other trading days.”  Figure 4 displays the growth of $1,000 invested in REPIX only during the trading days not listed above.repix 3

Figure 4 – Growth of $1,000 invested in REPIX only on “non favorable” days (Aug 2000-present)

$1,000 invested in REPIX only on all non-favorable seasonal days actually declined in value to just $82 (-92%).

So let’s sum up the results from August 2000:

 SPY: +39%

REPIX non-seasonally favorable days: -92%

REPIX seasonally favorable days: +2,469%

For the record, the difference in the relative rates of return listed above are what we “quantitative analyst types” refer to as “statistically significant.”

Summary

So is everyone going to now resolve to trade real estate stocks on certain days of each and every single month going forward?  Surely not.  This strategy has serious risk and volatility involved.  So this is not a “hey let’s bet the ranch” type of idea.  Still, a roughly 30% a year average annual return typically does involve some risk.

So most people will shy away from anything even remotely resembling what I have just described.  But if you carefully reread the section above titled “The Gist of Seasonal Trends” then you may come to understand that that is exactly my point.

Jay Kaeppel

The Truth about the Year-End Stock Market Rally

Yes, it really is “the most wonderful time of the year” – at least in the stock market.  But not always.  But usually.  In my book “Seasonal Stock Market Trends” (which may well be the gift that the trading loved one in your life secretly desires but is too shy to ask for, hint, hint) I wrote about “Holidays.” Starting with works from Hirsch, Fosback, Zweig, Eliades and whoever else I could think of to steal, er, borrow from, I looked at the performance for the stock market on each of the three days before and after a market holiday.

While I personally found the results to be interesting, it strikes me as curve-fitting to say something like “you should be long the stock market the second trading day before Christmas, the day after Thanksgiving , the second trading day after the 4th if July”, etc.  Instead I prefer to look at “holiday trading season” as the three trading days before and the three trading days after a market holiday, in totality.  So this week let’s look at the three trading days before Christmas through the three trading days after New Year’s period.

The Year-End Seasonal Pattern

To define things, we are looking specifically at the period that:

*Starts at the close of trading four trading days before Christmas (in this case, Friday, Dec. 19th, 2014)

*Ends at the close of trading on the third trading day of January (i.e., the third trading day after New Years, in this case, Tuesday, Jan. 6, 2015)

This period during the 2013-2014 year-end period is highlighted in Figure 1.DJIA year end Figure 1 – Bullish Year-End Period 2013-2014 (Courtesy: AIQ TradingExpert)

The Results

To get a true sense of the bullish bias during this period, Figure 2 displays the growth of $1,000 invested in the Dow Industrials ONLY during this “bullish year-end” period starting in December 1933.DJ Year EndFigure 2- Growth of $1,000 invest in Dow only during bullish year-end period

The annual results using the Dow Jones Industrial Average appear in Figure 2.

Period End Date DJIA %+(-)
01/04/34 3.67
01/04/35 5.12
01/04/36 3.28
01/05/37 1.83
01/05/38 (4.09)
01/05/39 2.41
01/04/40 2.21
01/04/41 2.74
01/05/42 5.95
01/05/43 0.88
01/05/44 2.05
01/04/45 2.54
01/04/46 0.15
01/04/47 (0.52)
01/06/48 (1.07)
01/05/49 0.41
01/05/50 1.70
01/04/51 4.03
01/04/52 1.34
01/06/53 1.98
01/06/54 0.34
01/05/55 (0.02)
01/05/56 0.45
01/04/57 0.63
01/06/58 2.62
01/06/59 3.18
01/06/60 0.99
01/05/61 1.28
01/04/62 0.02
01/04/63 2.35
01/06/64 0.74
01/06/65 1.14
01/05/66 3.09
01/05/67 1.37
01/04/68 2.05
01/06/69 (3.95)
01/06/70 1.75
01/06/71 2.00
01/05/72 2.19
01/04/73 3.04
01/04/74 6.11
01/06/75 5.42
01/06/76 5.50
01/05/77 0.58
01/05/78 (0.16)
01/04/79 4.59
01/04/80 (1.20)
01/06/81 7.20
01/06/82 (1.38)
01/05/83 4.02
01/05/84 3.24
01/04/85 (1.91)
01/06/86 0.24
01/06/87 3.24
01/06/88 2.38
01/05/89 1.13
01/04/90 3.73
01/04/91 (2.31)
01/06/92 13.41
01/06/93 (0.22)
01/05/94 1.16
01/05/95 2.22
01/04/96 1.25
01/06/97 1.44
01/06/98 1.93
01/06/99 6.19
01/05/00 (0.19)
01/04/01 3.10
01/04/02 1.88
01/06/03 4.89
01/06/04 2.53
01/05/05 (0.60)
01/05/06 0.71
01/05/07 (0.59)
01/04/08 (3.08)
01/06/09 5.08
01/06/10 1.53
01/05/11 2.13
01/05/12 2.58
01/04/13 1.38
01/06/14 0.87
Average 1.88
Median 1.83
Maximum % 13.41
Minimum % (4.09)
# Times Up 66.00
# Times Down 15.00
% Times Up 81.48
% Times Down 18.52

Figure 2 – Year-by-Year Results; Year-End Rally

As you can see in Figure 2, there is some good news and some bad news, but mostly good news. To wit:

*This period has showed a gain 81.5% of the time.

*This period is in no way “guaranteed” to result in a profit as it has showed a loss 18.5% of the time

*The largest up period was +13.41% (1991-1992)

* The largest down period was -4.09% (1937-1938)

*The “average winning trade” and “median winning trade” was +2.62% and +2.16%, respectively.

*The “average losing trade” and “median losing trade” was (-1.42%) and (-1.07%), respectively.

Summary

So is the stock market “sure to rally” between now and 1/6/15? Of course not.  Nevertheless, the results displayed above suggest that traders are typically wise to give the bullish case the benefit of the doubt during the Christmas/New Year’s Holiday Seasonal.

Wishing all JayOnTheMarkets.com readers a “Very Merry Christmas and a Happy New Year” (unless of course, you are offended by this, in which case, wishing you “Whatever”.)

Jay Kaeppel

If You Just Have to Pick a Bottom in Crude Oil…

OK, let’s be candid about this title.  The reality is that no one ever “has to pick a bottom.”  In fact, we are advised time and again to avoid this very activity as it is considered to be “dangerous”, “foolhardy” and/or “unlikely to succeed”, depending on the person dispensing the wisdom.

Still, if you are reading this article then chances are you are doing so because at some point in your (checkered?) trading past you have either been tempted to “pick a bottom (and/or top)” or you have actually tried to do so.  So you know deep down that it is probably not a very good idea.  Still, it sure is tempting isn’t it?  I mean let’s be honest here.  Who doesn’t want to be able to say they “picked the bottom” in, well, something, whatever. And you sure can make a lot of money if you get in at exactly the right moment.

So let’s dispense with niceties and conventional wisdom and acknowledge the fact that we are in fact imperfect beings, complete with foibles, faults, bad habits and extremely subject to human nature (and isn’t that a pain in the rear).  So if you consider yourself to be a “trader” it may be hard to look at the recent freefall in oil and perhaps gold prices and not say “Man, this thing is due to bounce.  I wonder if there is a way to play this?”  So let’s take a look at one way to play a potential bounce in crude oil.

A Few Important Caveats

1) I haven’t the slightest idea if crude oil will bounce soon or not.  In fact, if my gut told me that it was then my first reaction would likely be to ignore it (but enough about my own personal psychoses’).

2) Regardless of whatever the rest of this article says the cold hard reality is that this exact moment in time is probably not the moment that crude oil will bottom out.  In fact, it could continue to fall precipitously for some time to come.

3) Yes, trying to pick a bottom in anything is in fact analogous to attempting to catch a falling knife. It’s a really cool trick if it works, but it can get a little messy otherwise.

So I am NOT “predicting” that crude is about to bounce and I am NOT recommending that you take the trade I will discuss in a moment.

So what is the point?  The point is this: There is a right way and a wrong way to do everything, no matter how wise or foolish the current “thing” in question may be.  If you are going to pick a bottom then you want to do two things:

1) Understand going in that you are playing a long shot so prepare yourself mentally in advance to fail (in fact you might even want to go ahead and prepare yourself to kick yourself and say “What the heck was I thinking about?”).

2) Do everything possible to minimize your risk based on current circumstances.

One Way to Play a Bounce in Crude

OK, all caveats out of the way, let’s now go ahead and “take the plunge.”  A few key factors:

1) My own personal opinion is that any trade that attempts to pick a top or bottom should involve the use of options.  Why?  Simple – limited risk.  To better appreciate this, imagine the poor schlub who bought a January 2015 crude oil futures contract on 10/3 when the 2-day RSI (which I like by the way) dropped below 5, thus strongly suggesting that crude oil was “oversold”.  As you can see in Figure 1, since that time, Jan2015 CL has fallen from 87.87 to 55.91. At $1,000 a point, that works out to a loss of -$32,900 per contract.  Ouch.  And thanks for playing our game.cl f1

Figure 1 – “Oversold” Crude Oil not such a Bargain (Courtesy: AIQ TradingExpert)

2) The current “waterfall” decline in crude is not without precedent.  In Figure 2 – which displays a continuation chart of crude oil futures – you can see several occasions when the bottom dropped out of crude oil, so to speak.  In the past these types of declines have typically lasted 3 to 8 months.  The current decline is in its 6 month. Likewise, as of 12/16, the monthly 2-month RSI was at its lowest reading in 30+ years of trading.  The point here is not to argue that a reversal is imminent, only that it isn’t entirely crazy to think that a bounce is possible.cl f2Figure 2 – Crude Oil “waterfall declines” past and present (Courtesy: AIQ TradingExpert)

The least expensive way to play a potential bounce in crude oil is via options on ticker USO, the ETF that tracks (more or less) the price of crude oil.  In Figure 3 you see the USO bar chart with the 90+ day implied option volatility plotted.

cl f3Figure 3 – Implied Volatility for USO options has “spiked” (Courtesy: www.OptionsAnalysis.com)

IV has spiked to its highest level in years.  This has important implications for option traders. High implied volatility simply tells us that there is a lot of time premium built into the price of USO options.  As a result, traditional bullish strategies such as buying calls or bull call spreads may be poor choices for someone looking to play a bounce.  This is because implied volatility typically (albeit not always) declines when a security bounces higher off of a panic selling bottom.  Selling a bull put spread might make sense as an alternative.  However, I personally don’t advocate that strategy in the face of an ongoing waterfall decline.  A bull put spread is best used when there is some sort of support level that a trader can use as an “uncle” point.

So what to do?

What to Do

Well as I stated earlier, for the vast majority of traders the best course is to “do nothing” and NOT attempt to pick a bottom in crude.  However, we are talking about what actions a trader might consider if he or she has decided to “take a flyer”.  So here is one possibility – a “Reverse Call Calendar Spread.”

As long as we are breaking all the rules I think it is OK to point out that a reverse calendar spread is a strategy that most traders will never use, and in most cases should never use.  But every tool has its use.  What we are looking for in this case is:

1) Price movement between now and the first week of February, and;

2) A decline in implied volatility

So one way to play is:

*Buy 1 Feb 2015 21 Call @ 1.46

*Sell 1 Mar 2015 21 Call @ 1.77

The prospects for this trade appear in Figures 4 and 5.cl f4Figure 4 – Reverse call calendar spread for USO (Courtesy: www.OptionsAnalysis.com)cl f5Figure 5 – Reverse call calendar spread for USO (Courtesy: www.OptionsAnalysis.com)

A few key things to note for starters:

1) Assuming this trade is held until February expiration and implied volatility remains unchanged this trade (based on a 1-lot) has $31 of profit potential and $80 of risk.

2) “Vega” represents the amount that the trade will gain or lose if implied volatility rises by 1 percentage point.  This trade has a Vega of $-0.67.  This means that if volatility keeps rising lose potential may also increase.  However, if IV falls the profit potential for this trade will increase.  If IV falls 10 percentage points the profit on this trade will increase (roughly) $6.70.

3) Implied volatility for the options in this trade are extremely high (45% or more) on a historical basis.

4) From a risk management perspective the most important thing to note is that this trade should NOT be held until February option expiration.  By planning to be out no later than two weeks prior to expiration (i.e., by Feb. 6) we completely eliminate that potential of experiencing the maximum potential loss, and in fact reduce the worst case scenario significantly.

Let’s make the following assumptions to highlight exactly what this trade is designed to achieve.  The information in Figures 6 and 7 assume:

1) That the trade will be held no later than Feb. 6, and;

2) That implied volatility falls 40% from current level (i.e., current IV x 0.6)

In Figures 6 and 7 you clearly see the potentially positive implications for a meaningful decline in implied volatility.cl f6Figure 6 – USO reverse calendar if IV declines back under 30% (Courtesy: www.OptionsAnalysis.com)cl f8Figure 7 – USO reverse calendar if IV declines back under 30% (Courtesy: www.OptionsAnalysis.com)

In this scenario, the maximum risk declines to roughly -$5 on 1-lot and the break-even range is greatly compressed thus significantly raising the probability of a profitable trade.

Summary

So all in all, it is typically a bad idea to try to pick a top or bottom in the financial markets.  But all of us are human, and human nature can occasionally lead a trader to “feel the urge.”  If the urge is too great and you feel you must act, then remember to do everything in your power to limit your risk.

If your bottom picking trade works out, great (but don’t let it go to your head).  And if it does not, then at least you didn’t “bet the ranch.”

Jay Kaeppel

Seasonal E-mini Strategy – 42 Wins and 0 Losses?

Don’t you just hate titles like this one?  I mean if you are into the stock market you almost can’t help but to click on it – even if for no other reason than to seek the answer to that age old question, “What’s the catch?”

Now in this case the title is accurate, at least in the hypothetical sense.  But as you probably know, for any book, article or publication the name is everything.  For example, if the title of this article were “Would You Be Willing to Risk $3,000 on a Trade for the Chance of Making as Little as $25 on Said Trade?” (which would also be hypothetically accurate), you would be a lot less likely to click on the link, right?  I mean let’s be honest here.

So, yes, technically you can’t judge a book (article or publication) by its cover.  But in reality, we all do it all the time.  So just remember that  the people designing the covers have a vested interest in getting you to open the cover, so be forewarned.

Hence the title of this article.  But since you’ve already “cracked open the cover”, why not read on a little further?  (Insidious, no?)

A Seasonal Oversold “Idea”

Note the use of the word “Idea” in the section title.  And also please remember that the word “idea” is quite different from the words “sure” and/or “thing” and way different from the phrase “you can’t lose.”  So again, be forewarned.  In the interest of full disclosure I am not attempting to urge you to use the “idea” spelled out below – only to be “aware” of it and to consider whether or not it might “fit your style.”

So what’s this all about?  Simple.  Awhile back I wrote a piece titled “Happy Days are Here, Um, Next Monday?” that in a nutshell highlighted the fact that the stock market tends to perform well between the close of trading on the Friday before Thanksgiving and the close of the third trading day of the following January.  The “idea” in this article builds from that trend.

Entry Rules

Here are the “rules” (to paraphrase the immortal words of Bill Murray, they are really “guidelines” more than “rules”, but here goes):

*If today is between (and including) the Friday before Thanksgiving and the third trading day of the New Year, AND;

*The 2-day RSI is below 30, a “buy alert” is signaled.

*After a “buy alert” occurs, a “buy signal” occurs when the E-mini S&P 500 exceeds a previous day’s high price (however, a “buy signal” cannot occur after the third trading day of January).

Exit Rules (OK, again – Guidelines):

*Sell if the E-mini S&P declines 60 (i.e., $3,000 per contract) points from the buy trigger price (i.e., the previous day’s high + 0.25 points), OR

*On the first profitable close.

Results

Starting in November 2004 there have been 42 trades.  During this time there have been no post buy declines of 60 points (although a few have come close), hence the reason no losing trades.

Figure 1 displays the most recent signal using the December 2014 E-mini S&P 500 contract.

es-ss 1 Figure 1 – Seasonal Oversold Trade for 2014-2015 (so far); Source: AIQ TradingExpert

Figure 2 displays the trades from the 2013-2014 periods. es-ss2Figure 2 – Seasonal Oversold Trade for 2013-2014 (Source: AIQ TradingExpert)

Figure 3 displays the trades from the 2012-2013 periods.

es-ss3

Figure 3 – Seasonal Oversold Trade for 2012-2013 (Source: AIQ TradingExpert)

Figure 4 displays the trades signaled each year during the bullish seasonal period (assuming a 1-lot per trade).

Trade # Entry Date Exit Date Buy Price Sell Price Points +(-) per Trade $ +(-) per Trade MaxDD Pts. per Trade MaxDD $ per Trade
1 11/23/04 11/24/04 1179.25 1182.00 2.75 $137.50 (7.75) ($388)
2 12/01/04 12/01/04 1179.75 1189.75 10.00 $500.00 (4.75) ($238)
3 12/09/04 12/09/04 1187.00 1190.75 3.75 $187.50 (11.25) ($563)
4 12/20/04 12/21/14 1203.75 1208.00 4.25 $212.50 (8.50) ($425)
5 12/01/05 12/01/05 1263.25 1264.50 1.25 $62.50 (11.50) ($575)
6 12/12/05 12/13/05 1272.75 1277.00 4.25 $212.50 (9.00) ($450)
7 12/21/05 12/22/05 1272.25 1275.50 3.25 $162.50 (5.50) ($275)
8 01/03/06 01/03/06 1259.25 1274.75 15.50 $775.00 (7.75) ($388)
9 11/29/06 11/29/06 1392.75 1402.25 9.50 $475.00 (0.50) ($25)
10 12/11/06 12/14/07 1428.00 1438.25 10.25 $512.50 (11.00) ($550)
11 12/27/06 12/27/06 1431.25 1437.00 5.75 $287.50 (0.25) ($13)
12 11/23/07 11/28/07 1440.00 1442.00 2.00 $100.00 (33.25) ($1,663)
13 11/26/07 11/28/07 1444.25 1470.50 26.25 $1,312.50 (37.50) ($1,875)
14 11/28/07 11/28/07 1441.25 1470.50 29.25 $1,462.50 (0.25) ($13)
15 12/05/07 12/05/07 1478.00 1487.00 9.00 $450.00 (1.25) ($63)
16 12/19/07 12/20/07 1471.75 1474.75 3.00 $150.00 (16.00) ($800)
17 11/24/08 11/24/08 814.50 848.00 33.50 $1,675.00 (7.25) ($363)
18 12/03/08 12/03/08 851.00 868.50 17.50 $875.00 (24.75) ($1,238)
19 12/16/08 12/16/08 885.50 912.75 27.25 $1,362.50 (9.75) ($488)
20 12/26/08 12/29/08 870.00 870.50 0.50 $25.00 (16.75) ($838)
21 11/23/09 11/23/09 1102.50 1103.75 1.25 $62.50 (1.25) ($63)
22 12/01/09 12/01/09 1104.75 1108.50 3.75 $187.50 (2.50) ($125)
23 12/04/09 12/22/09 1112.25 1113.50 1.25 $62.50 (3.75) ($188)
24 12/10/09 12/11/09 1097.75 1103.25 5.50 $275.00 (5.25) ($263)
25 12/21/09 12/22/09 1107.75 1108.25 0.50 $25.00 (11.25) ($563)
26 01/04/10 01/04/10 1124.25 1128.75 4.50 $225.00 (4.75) ($238)
27 11/24/10 12/01/10 1187.75 1196.50 8.75 $437.50 (11.50) ($575)
28 12/01/10 12/01/10 1197.50 1204.50 7.00 $350.00 (0.50) ($25)
29 12/16/10 12/21/10 1244.50 1250.75 6.25 $312.50 (12.00) ($600)
30 01/03/11 01/03/11 1258.50 1265.25 6.75 $337.50 (3.25) ($163)
31 11/28/11 11/28/11 1174.50 1191.00 16.50 $825.00 (5.25) ($263)
32 12/09/11 12/09/11 1250.50 1253.00 2.50 $125.00 (17.75) ($888)
33 12/15/11 12/20/11 1218.75 1236.00 17.25 $862.50 (23.25) ($1,163)
34 12/20/11 12/20/11 1218.75 1236.00 17.25 $862.50 (20.00) ($1,000)
35 12/30/11 01/03/12 1258.75 1272.00 13.25 $662.50 (8.00) ($400)
36 12/05/12 12/06/12 1412.00 1413.00 1.00 $50.00 (15.25) ($763)
37 12/17/12 12/17/12 1419.50 1427.00 7.50 $375.00 (10.25) ($513)
38 12/26/12 01/02/13 1424.75 1457.00 32.25 $1,612.50 (42.50) ($2,125)
39 12/31/12 12/31/12 1417.00 1420.00 3.00 $150.00 (33.50) ($1,675)
40 12/06/13 12/06/13 1794.50 1803.75 9.25 $462.50 (8.75) ($438)
41 12/16/13 12/16/13 1783.25 1786.00 2.75 $137.50 (17.75) ($888)
42 12/02/14 12/02/14 2061.25 2066.00 4.75 $237.50 (10.50) ($525)
Points $ Points $
Average 9.32 $466 (11.74) ($587)
Median 6.00 $300 (9.38) ($469)
Max 33.50 $1,675 (0.25) ($13)
Min 0.50 $25 (42.50) ($2,125)

Figure 4 – Hypothetical Trade-by-Trade Results

A few things to note:

*42 winners, 0 losers

*Maximum drawdown per 1-lot = -$2,125

*Average winner in points (dollars) = +9.32 (+$466)

*Median winner in points (dollars) = +6.00 ($300)

*Average Maximum drawdown per trade in points (dollars) = -11.74 (-$587)

*Median Maximum drawdown per trade in points (dollars) = -9.38 (-$469)

Summary

So on the face of it, anything that is capable of generating 42 consecutive winning trades would seem to have some merit to it.  On the other hand, with any trading method it is critically important to look “under the hood” and make some realistic assessments regarding the actual usefulness of said method.

The system rules include a 60 point stop-loss for the E-mini S&P 500 futures contract.  At $50 a point, this equates to a potential loss of $3,000 per contract per trade.  The average dollar profit was only $466 and the median dollar profit per trade was $300.

The key elements of risk in this method then are:

1) One losing trade of $3,000 could require a number of trades to come back from.

2) Using a tight stop-loss will result in a number of losing trades that would ultimately have ended up winners.

So the question for a trader to ask is – can we judge this book by its cover?

Jay Kaeppel

Three Sector Funds for December

December has historically been a bullish month for the stock market. In fact, over the past 24 years, buying and holding an S&P 500 Index fund during the month of December would have netted a gain 20 times, or 83.3% of the time, with an average gain of almost +2% (+1.93% actually).  A lot of investors might be tempted to say “That’s good enough for me”, and who could blame them?

But there might be a way to do even better.

Certain sectors show historical tendencies to perform well during certain times of the year.  So let’s look at a simple 3 fund portfolio that has performed quite a bit better than the S&P 500 over the past 24 years.

The “December Three”

The three sectors are Biotech, Software and Home Construction.  Figure 1 displays some potential trading vehicles.

Sector Fidelity ETF
Biotech FBIOX IBB
Software FSCSX VGT
Home Construction FSHOX XHB

Figure 1 – Fidelity and ETFs

Results

For testing purposes we will use the Fidelity funds listed in Figure 1 as they have historical data going back much further than the ETFs listed.

Figure 2 displays the annual result of a portfolio split evenly between the three funds versus the S&P 500 Index.

Fid 3

Figure 2 – Annual Results: 3 Fidelity Sector Funds vs. SPX

Figure 3 displays the growth of $1,000 invested only during the month of December in the “Fidelity 3” versus the S&P 500 Index. Fid 3 chartFigure 3 – Growth of $1,000 invested in Fidelity 3 versus SPX (1990-2013)

Figure 4 displays the relevant comparative figures.  fid 3 results

Figure 4 – Comparative Results

A few things to note:

*The Fidelity 3 has gained an average of +4.21% versus +1.93% for SPX.

*The Fidelity 3 median gain was +2.52% versus +1.25% for SPX.

*The Fidelity 3 has showed a higher standard deviation, but also a *higher Average/Standard Deviation.

*The worst December for the Fidelity 3 was -4.99% versus -6.03% for SPX.

*Interestingly, the Fidelity 3 has been up 19 times and down 5, versus up 20 and down 4 for SPX.  However – and most importantly – the Fidelity 3 has outperformed SPX in 18 of the past 24 years.

Summary

So are biotech, software and home construction guaranteed to show a gain and outperform the S&P 500 this December.  Not at all.

But for an investor looking to “beat the market”, it certainly is “food for thought.”

Jay Kaeppel

Happy Days Are Here, Um, Next Monday?

It is not a little known fact that historically the action of the stock market has been relatively favorable both around holidays and towards the end of the year.  But some question remains as to just how favorable things have been during these periods and how often.  So let’s address it.

The Year-End (or “Santa Claus”) Rally

Different analysts will look at historical data and draw different conclusions.  This is actually a good thing, otherwise everyone would be trying to buy or sell at the same time.

But in the opinion one analyst (“Hi, my name is Jay”) the “year-end rally” period (or as I like to call it the “Santa Claus Rally”):

*Starts on the Monday before Thanksgiving

*Ends at the close of the third trading day of the following January

Have I mentioned lately that this stuff doesn’t need to be rocket science?

So how has this period performed?  We will start our test at the close of trading on Saturday (yes, Saturday) November 19, 1949 and examine what would have happened to a hypothetical $1,000 investment in the Dow Jones Industrials Average that was in the market only during the bullish year-end period described above (in other words, the trader would buy the Dow Industrials Average at the close on the last trading day prior to the Monday before Thanksgiving and would hold through the close of the third trading day of the following January.  The rest of the time the “system” is out of the market.  For our purposes, no interest is earned so as to reflect only the gains made during the bullish year-end period).

The results appear in chart form in Figure 1.santa rallyFigure 1 – Growth of $1,000 invested in the Dow Industrial Average only during the bullish year-end period described in text

Figure 2 displays the annual year-by-year results in table form.

Exit Date

% +(-)

1/5/50

3.6

1/4/51

4.0

1/4/52

3.9

1/6/53

4.6

1/6/54

2.9

1/5/55

5.1

1/5/56

0.2

1/4/57

3.7

1/6/58

(0.0)

1/6/59

5.7

1/6/60

5.8

1/5/61

3.2

1/4/62

(1.0)

1/4/63

5.0

1/6/64

8.2

1/6/65

(1.2)

1/5/66

3.0

1/5/67

(0.5)

1/4/68

4.3

1/6/69

(3.1)

1/6/70

(2.4)

1/6/71

10.0

1/5/72

11.6

1/4/73

3.4

1/4/74

(1.2)

1/6/75

3.6

1/6/76

6.0

1/5/77

3.1

1/5/78

(3.7)

1/4/79

3.6

1/4/80

1.6

1/6/81

1.5

1/6/82

0.9

1/5/83

2.3

1/5/84

2.5

1/4/85

(0.3)

1/6/86

5.7

1/6/87

4.3

1/6/88

6.5

1/5/89

6.2

1/4/90

5.4

1/4/91

0.6

1/6/92

13.9

1/6/93

2.4

1/5/94

2.8

1/5/95

0.9

1/4/96

3.7

1/6/97

1.5

1/6/98

0.3

1/6/99

4.2

1/5/00

1.1

1/4/01

2.7

1/4/02

4.0

1/6/03

(0.4)

1/6/04

9.5

1/5/05

1.3

1/5/06

1.1

1/5/07

0.4

1/4/08

(2.9)

1/6/09

12.0

1/6/10

2.5

1/5/11

4.6

1/5/12

5.3

1/4/13

6.7

1/6/14

1.6

Figure 2 – Year-by-Year “Santa Claus Rally” % +(-)

A few performance notes:

# times UP = 54 (83% of the time)

# times DOWN = 11 (17% of the time)

Average% +(-) = +3.19%

Median % +(-) = +3.08%

Largest % Gain = +13.87% (1991-92)

Largest % Loss = (-3.69%) (1977-78)

It is also worth noting that the year-end rally period has witnessed a gain for the Dow in 27 of the last 29 years and 33 of the last 36 years.

Summary

So do the results displayed in Figures 1 and 2 guarantee that the stock market is destined to rally in the near future?  Ah there’s the rub.  For the answer is “not necessarily”.  Still, investing is in many ways a game of odds and probabilities.  While one always needs to be prepared to act defensively if things start to go south, history suggests that traders and investors might do well to give the bullish case the benefit of the doubt between Thanksgiving Week and early January 2015.

Or to put it more succinctly:

Jay’s Trading Maxim #215: Santa Claus is real (approximately 83% of the time).

Jay Kaeppel

Darknet Channels Strikes Again

In the May 2014 issue of “Technical Analysis of Stock, Commodities & Forex” magazine, I co-authored an article with John Broussard, a former colleague of mine.  John is the purveyor of www.OptionsAnalysis.com and developer of the Darknet Channels trading method.

Now when I say that we “co-authored” the article, in this case that breaks down sort of like this:

John: Researched, tested, designed, developed, programmed, refined, launched and maintains the Darknet Channels system.

Jay: Ran spell check and grammar check.

In addition, Jay also wonders why – even though John thoroughly explained the calculations and methodology behind Darknet Channels – he still doesn’t full understand exactly how they work.  Alas, some questions are best left unanswered.  But hey, at least the spelling and grammar look good.

Darknet Channels: The Broad Stroke

In a nutshell, Darknet Channels involves calculations that draw three sets of price channels which we will refer to as long, intermediate and short-term channels.  When all three sets of channels are pointing lower and long short-term and intermediate-term channels are contained within the longer-term channels, then the stage is set for a buy signal (a reversal in price is required first in order to avoid attempting to “catch a failing safe”).

Once a buy signal occurs then the system looks for the opposite configuration – i.e., all three channels are pointing higher and the short and intermediate-term channels are contained within the longer-term channels.  Then the stage is set for a sell signal.  Once again, reversal in price of some degree is required to trigger the actual signal. 

Figure 1 displays some recent example signals for ticker SPY.spy darknetFigure 1 – Darknet Signals for SPY

Trading with Darknet Channels

www.OptionsAnalysis.com generates Darknet Signals for a large number of stocks.  Also, the software generates signals on Stocks, Call Options and Put Credit Spreads.  It likewise has its own built in methodology for selecting specific options to trade. 

Not being one to leave well enough alone (Sorry, its jut my nature), I have my own list of tickers that I follow and my own method for selecting call options to consider based on the trading signals that the software generates.

My “short list” of tickers includes:

AXP BA DIA EEM IBB IWM SPY SSO XHB XLB XLF XLI XLP XLV XLY XOP

Also the method I use for selecting options for consideration uses the following inputs in the % to Double routine built into www.OptionsAnalysis.com:darknet input 

Figure 2 – Jay’s Option Selection Inputs

The primary things to note among the inputs are:

*At least 45 days until expiration

*Volume and Open Interest of at least 1 (i.e., ignore call options that never trade)

*Use the “Natural” price (i.e., the ask price) for evaluation purposes (this give you an idea of what price you might get if you placed a market order)

I make no claim that these are the “best” selection criteria to use.  They are based on certain personal preferences (I would rather buy a slightly longer term option than to have to “roll out”, I don’t like to look at options that never trade and I like to consider my “worst case, what price do I buy at if I place a market order” scenario, rather than assuming that I can get filled at the midpoint of the bid/ask spread).  That being said, traders may often be better off buying with a limit order than a market order.  

In sum a trader can follow the trades suggested by the software, use the criteria I have listed above, or device some other variation – for example, some traders might consider deep-in-the-money call options as a “stock replacement” strategy.

Some Recent Results

The results displayed in Figure 3 are hypothetical and represent just one recent set of results from using Darknet Channels buy signals and the option selection criteria shown above.  It is assumed that $2,500 is dedicated to each trade.darknet hypothetical results Figure 3 – Hypothetical Results of Recent Darknet Channels signals

The results in Figure 3 do not include any deductions for slippage or commissions, so net returns would be less than they appear in this table.  Still, the gist is that investing up to $2,500 into each of these 8 positions – at a cost of around $20,000 – would have generated close to a doubling of capital before slippage and commissions.

Summary

No trader should look at any set of hypothetical results and come away with stars in their eyes.  The market had a great rally off of the October low so good gains were obviously there for the taking for call buyers.  But the real point of this piece is not so much to “sell” you on Darknet Channels as it is to make you “aware” that a mechanical and back tested model is available that can generate these types of returns under the right circumstances. 

For more information visit www.OptionsAnalysis.com.

Jay Kaeppel