A Trade for September
Among traders, September is the most feared month of the year. A recent article in Barron’s highlighted the confluence of negative seasonal trades that come together in the month.
To start with, we are still in the stock market’s worst six months. This is the period covered by the saying “sell in May and go away.” This time frame runs through the end of October.
But, the Stock Traders Almanac has a different version of that old saying, based on the longer history of stock market trading in London.
The old adage suggested, “to sell in May and go away, and come back on St. Leger’s Day.” The latter referred to the St. Leger’s Stakes, an English horse race held in mid-September. This year’s race is scheduled for September 16 so there could be a rally late in the month.
The Chart Confirms the Cause for Concern
Traders talk about the worst six months for a reason. The broad stock market does show a tendency to be weak in those six months. The chart below shows the seasonal trend for September is down. That trend is shown as the solid blue line.
The seasonal trend is calculated from previous price action. There are several techniques that can be used but they all “detrend” the data. This requires isolating the price action for a single time period by removing the longer term trend in the data.
Seasonal trends are not precise forecasts of what will happen in the market but they are one factor that should be considered. They do show long term trends in money flows, for example, and it is possible some of the selling pressure in September is associated with the need to raise cash by nonprofits who use a fiscal year ending on September 30.
Another Seasonal Trade for the Bears
According to Barron’s, another market adage is to “sell Rosh Hashanah, buy on Yom Kippur.” This saying is based on the belief that observant Jewish investors would tend to liquidate their portfolios for the High Holy Days, according to accounts going back more than a century.
Wall Street legend and long-time trader Art Cashin, the director of floor operations at UBS and frequent guest on CNBC, noted, “The thesis, I was told, was that you wished to be free (as much as possible) of the distraction of the worldly goods during a period of reflection and self-appraisal.”
This belief is confirmed by historians. A 2010 academic paper confirmed the story and showed that making that seasonal trade delivered “statistically and economically significant returns” for traders who sold the Dow Jones Industrial Average on Rosh Hashanah and bought on Yom Kippur from 1907 to 2008.
This effect was small. According to the paper, a trader would have had to invest $1 million to take a position in all 30 Dow components but would have yielded a return of about $10,095 in about two weeks.
“You could make a few dollars, but we don’t think you could get rich off it,” one of the authors said.
Rosh Hashanah this year begins at sunset on September 20. Yom Kippur will begin in the evening of September 29.
Other News Could Make September Volatile
We have a number of news stories to follow in September. The Federal Open Market Committee’s meeting begins on September 19. Fed Chair Janet Yellen’s quarterly press conference to discuss the panel’s policy decisions is set for September 20.
The Fed has been a primary driver of bullishness on Wall Street for the past few years. Policy changes could be bearish.
In Washington, the federal government’s fiscal year begins on October 1. That means Congress and the President need to agree on a budget or a continuing resolution to fund the government past September 30. Both sides have threatened a government shutdown.
This year’s budget timeline may be complicated by the looming debt ceiling debate. This crisis, the fact that government is pushing against the Congressional limit of its authority to borrow, has led to crises in the past. This year, the deadline is in early October although a precise date depends on budget gimmicks.
The Data Confirms a Reason for Concern
We also have data confirming the weakness of September. Baron’s noted, “we are “entering the only month of the year that has statistically significant negative returns,” writes Jeff deGraaf, head of Renaissance Macro Research, in a note to clients.” deGraaf is a former managing director at Lehman Brothers.
Since 1962, he calculates the S&P 500 has fallen an average of 0.67% in the month, the worst month of the year.
The Stock Traders Almanac confirms September is the worst month of the year. Since 1950, losses averaged 0.5% for the S&P 500 and 0.8% for the Dow. The Nasdaq Composite averaged a 0.5% loss since inception in 1971. The small cap Russell 2000 index also shows an average loss of 0.5% in September since it was started in 1979.
A Trading Strategy for the Month
The downward bias in September points to several possible trading strategies. The simplest one would be to buy a put option in the SPDR S&P 500 ETF (NYSE: SPY). This should benefit from a potential decline. These puts can be expensive because of the expected higher than average volatility in the month.
Volatility offers another potential trading strategy. In general, we expect volatility to rise when prices decline. This can be seen in the movement of the VIX index, an index also known as the fear gauge since it tends to rise when traders fear a decline in prices.
VIX can be traded indirectly with exchange traded notes, or ETNs. AN ETN is similar to an ETF in that they are liquid and easily traded. They differ in their underlying holdings. An ETF holds stocks while an ETN holds derivatives.
For VIX, a popular ETN is iPath S&P 500 VIX ST Futures ETN (NYSE: VXX), a product with more than $1 billion in assets. VXX is easily traded and has an active options market available. VXX generally rises as the S&P 500 declines. This is shown in the next chart.
VXX is shown as candlesticks and SPY is the solid line. The trends in the two tend to move in opposite directions.
To trade a market decline expected in September, options expiring on September 29 can be used. These options most closely track the timeline of the trade rational.
While the simplest strategy available with VXX is to by a call on VXX. Call options on VXX should gain as SPY declines since VXX and SPY are expected to move in opposite directions. However, calls on VXX are expensive.
For VXX, a September 29 call with an exercise price of $47 costs about $3.50. This call could be bought and a $53 call with the same expiration date could be sold for about $2. This creates a bull call spread that can benefit from an increase in the value of VXX.
In this trade, the total cost to open the position is about $1.50, or $150 since each contract covers 100 shares. The maximum loss on the trade is equal to the amount paid to open the trade.
The maximum gain on the position is equal to the difference between the strike prices less the premium paid to open the trade. In this case, that is $6 minus $1.50. That’s $450 for this trade, a potential return of 200% on the amount of capital risked.
VXX may be the best trade for the coming month when danger is high.