Options Trading and the “Sell in May” Phenomenon

by Tyler Craig | April 26, 2012 9:35 am

may 2011 calendar 250x150 Options Trading and the “Sell in May” Phenomenon[1]Much has been written about seasonal patterns in the financial markets. Certain months and even particular days of the month have a tendency to exhibit more bullish behavior than others. Additionally, particular sectors and industries may have specific times of the year when they consistently catch bull fever as well. In fact, within the body of knowledge known as Technical Analysis, there is an entire segment focused on the study of such cycles.

One of the more popular seasonal patterns sure to be increasingly bantered about as April comes to a close is “Sell in May and Go Away.” The catchy phrase illustrates the strong tendency for the stock market to underperform through the summer doldrums and into early fall.

According to The Stock Trader’s Almanac, investing $10,000 in the Dow Jones Industrial Average between November 1and April 30 from 1950 through 2009 would have generated a $527,388 compounded return.

Conversely, the same investment would have generated a $474 loss for May 1through October 31 over the same time period. The difference is staggering.

More recently, the infamous flash crash of 2010 and the U.S. credit-rating-downgrade-driven swoon of 2011 both occurred during the May – October period.

The tricky question, then, is how to allow this pattern to influence your trading. Should you batten down the hatches, hoard the canned food, load up on ammo, and take otherwise drastic measures?

Perhaps not.

I would treat the coming seasonally weak period as merely one piece of the puzzle, one more item of evidence tipping the odds in favor of less-bullish price action in the coming months. It’s not as if the turn of the calendar to May signals impending doom.

To be fair, it’s probably a pattern that’s more relevant to longer-term investors and largely irrelevant to active traders more concerned with follow-through than direction. A lot can happen in six months and we’re bound to see large swings in both directions.

If you’re one of those longer-term stock holders unwilling to part ways with your beloved positions, but want some type of protection for the coming “lackluster season”, try selling covered calls[2] or perhaps entering a collar trade[3].

If indeed the path of least resistance in the coming weeks to months is sideways to down, iron condors [4]and strategically placed bear call spreads[5] may also be strategies worth employing.

At the time of this writing Tyler Craig had no positions on the Dow Jones Industrial Average.

 

Endnotes:
  1. [Image]: http://investorplace.com/wp-content/uploads/2011/05/may-2011-calendar_250x150.jpg
  2. selling covered calls: http://investorplace.com/2012/01/options-made-simple-selling-covered-calls/
  3. entering a collar trade: http://investorplace.com/2010/05/options-collars-using-option-collars-to-hedge-in-a-volatile-market/
  4. iron condors : http://investorplace.com/2009/05/trading-iron-condors/
  5. strategically placed bear call spreads: http://investorplace.com/2012/04/play-the-selling-sequel-with-call-spreads/

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