Does January Forecast Year-End Direction?

 

 

 

 

 

 

 

 

 

When you see how the month of January ends (from its opening price on the first trading day to the last day of that particular month) you will see that the particular month ends either bullish or bearish.  This means that if the month of January opened at one price and closed at a higher price, we had a bullish month.  However if the opposite happens then we have a bearish month.

If you were to go back to 1989 you would realize an amazing consistent trend.  That trend is that depending on how the month of January closes (either bullish or bearish) it seems to dictate how we are going to end the year!  So when we look again at how January opens on the first day of trading and compare it to the last year of trading, January has already given us a high probability outcome.

Mirriam MacWilliams Jan Effect

What does this mean for me as an investor?  What it does not mean is that we will simply position our option trades to capitalize on a bullish strategy anticipating a bullish year-end.  Even though the market may signal a potential direction for the year it may still see some wild fluctuations that can and will impact your option position.

For example, in January 2009 we had a very bearish January.  As we all already know the bearish move that January was anticipating for the year was made in just the first quarter of that year causing the markets to then bounce and end the year quite bullish.

How to Use Market Volatility in Choosing Options?

Now that we know whether the year has a high probability of ending bullish (or bearish) can we simply Buy a longer-term option and participate or do we become the Seller of the option and capitalize on its time decay?  That depends on what the market volatility is at the time of our trading decision.  For example, I like to follow the $VXO (the volatility index for the S&P 100) as a measure of market volatility.

In January 2008 when the VXO was around 28% to 39% — I consider this a high volatile market – the Dow was having close to 275 to 400 point swings per day.  By October 2008 the VXO was now 40% – 80% and we are at extremes as far as market volatility goes.   We were seeing Dow swings of 400 – 800+ points per day.  This is all irrespective of the price on the Dow.  When the VXO is high then we can expect the Implied Volatility levels (IV) on many stocks to also go up and vice versa. So when are we Buyers of options and when are we Sellers of options?

My personal rule of thumb is that when the IV on a participate stock is 45% or higher then we need to be Seller’s of the option or at least participate in being Buyer’s of the option where our intention is to be in the trade just 2-4 days (my preference).

As the $VXO begins to drop – the market ranges also drop – the implied volatility levels on many of our options also drop.  The time is ripe to participate in being a Buyer of the option with a longer-term perspective (the probability is the greatest that the IV can either stay at those low levels or go up, ideal once we are already in a trade).  I look for IV levels that are below 45%.   I can always expect to be in the trade just 2-4 days however just remember that the IV’s are now dictating lower price ranges for the stock and now armed with that information I have a cool bench market for timing my exit!

As you can now see, whether the market has a high volatility or a low volatility, whether the market is going up or down – it is always a great time to participate in trading options!  Just be aware that participating in individual stocks and the trading of options still takes skill and knowledge.