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Around this time of year, we usually start to hear about the “January effect,” which is said to cause stock prices to rise in January following tax-loss selling in December. However, according to my research, that is more of a myth than many think.
Over the last 20 years, that has not occurred, as most of the buying actually happens in the month of December rather than January. December is typically one of the best-performing months of the year for the broad market, and especially the small-caps.
On the other hand, there may be an incentive to sell in December this year, particularly by the big money-managers, because the new tax bill is going to be uncomfortable for many of their firms. Most of these money-managers are operating in states that have very high state and local taxes, which are no longer going to be exempted under the new tax bill, and that is going to motivate many of them to take profits and get out of the market before the beginning of 2018.
The companies that are going to benefit the most from the tax bill, however, are the small-cap companies, which means that they may have a bullish advantage over the rest of the market. So, the opportunity I see today is a bullish position on iShares Russell 2000 Index (ETF) (NYSEARCA: IWM):
Using a spread order, sell to open the IWM Jan. 5th $142.50 put and buy to open the IWM Jan. 5th $130 put for a net credit of about $0.28.
Note: There are several January expirations available for IWM options. Be sure you are opening the weekly options that expire on Friday, Jan. 5, 2018.
Put credit spreads like these are bullish positions that involves writing (selling to open) an option and simultaneously purchasing (buying to open) an option at a different strike price in the same underlying security. The position, or leg, of the spread trade that you sell gives you a cash credit to your trading account. The option you buy limits your risk and lowers your margin requirement for the trade.
Ultimately, you want the underlying share price to stay above the upper strike price of the spread. In this case, we want IWM to stay above $142.50 through the Jan. 5 expiration. As long as that’s the case, we’ll ultimately walk away with full profits.
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