Put a Small Cap on Your Holiday Cheer

by Tyler Craig | November 30, 2012 10:37 am

Put a Small Cap on Your Holiday Cheer

The antics of the market over the past few weeks illustrate precisely why it’s so important to maintain flexibility and remain open-minded.

The post-election hangover and fiscal cliff worries led to a seven-day swoon that made it appear as if the market would never rise again. Fast forward to today, and the market — at least as measured by the Nasdaq Composite Index — is up almost nine days in a row and has officially reclaimed all of its post-election losses.

With the market being pulled back from the brink, it appears normal seasonality might be able to exert its typical influence. Historically, the month of December ushers in a period of good cheer and optimism[1] among the denizens of Wall Street. When the S&P 500 is having a positive year, good ol’ Saint Nick tends to close things out in bullish fashion.

Here’s a telling stat Bespoke Investment Group highlighted earlier in the week:

“When the S&P 500 has been up between 5% and 15% year-to-date thru November, it has gained in December 20 of 21 times.”

In light of the high odds for a strong close to the year, how about a bullish options play on the small cap-laden Russell 2000 Index, which has been leading the charge higher since the Nov. 16 lows?

RUTchart 300x204 Put a Small Cap on Your Holiday Cheer
Click to Enlarge
Traders could sell a Dec 785-775 bull put spread for $1 credit or better. The maximum reward is limited to the initial credit received and will be captured as long as the RUT doesn’t fall beneath $785 by December expiration. The max risk is limited to the distance between strikes minus the net credit, or $9.

Because of the high probability of the play, the risk-reward tradeoff is a bit lopsided. However, traders can drastically reduce the risk by exiting the position early if the current market rally falters. Thursday’s lows around the 795 area should provide support on any pullback, so you might consider using a break of that price level as a signal to exit to minimize losses.

As of this writing, Tyler Craig owned neutral option positions on the RUT.

Endnotes:
  1. the month of December ushers in a period of good cheer and optimism: http://investorplace.com/2012/11/3-etfs-that-should-thrive-in-november-xhb-xle-gdx/

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