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Yes, there is a Santa Claus... a Santa Claus Rally, that is. And there's 74 years of market history that proves it. In almost every December since 1945, the S&P 500 rose nearly 1.5% - advancing in price 73% of the time.
Just like Christmas itself, I look forward to the Santa Claus Rally pattern every year, and this year is no exception.
The market phenomenon runs from the first trading day after Christmas - Dec. 28, 2020 - and runs until the second trading day of the New Year - Jan. 5, 2021.
Time and time again we've cashed in on this, and this year, I've got a setup that could potentially return 150% by Jan. 8.
The Santa Claus Rally Is One Heck of a Tree-Topper
The Santa Claus Rally has occurred 65% of the time over the past 74 years for an average return of 1.3%.
Now, admittedly, 1.3% doesn't sound too impressive, particularly if you're a novice trader. But that's an average for all stocks. In practice, massive gains can be had on individual stocks and sectors. And with the incredible leverage of options, it's possible to turn a 1.3% move into triple-digit gains.
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Say you were to buy the SPDR S&P 500 ETF (NYSEArca: SPY) on Dec. 28 of this year and sell it on Jan. 5, 2021 - you'd have a 65% historic probability of making 1.3%.
I think we can all agree that's nothing to write home about.
Now, even with the increased return on investment (ROI) from options contracts, you can estimate the return by multiplying the historic ROI by 10 - meaning you'd receive a 13% return.
Not bad, but we can do better.
Because we know the S&P 500 tends to rise during this time, it means we can take the top stocks from this index to find an edge. And we can amplify this edge by picking stocks that historically move up during this period.
Over the past 10 years, the following five stocks have consistently outperformed the general market during the Santa Claus Rally:
Netflix Inc. (NASDAQ: NFLX)
Chipotle Mexican Grill Inc. (NYSE: CMG)
Intuitive Surgical Inc. (NASDAQ: ISRG)
Lockheed Martin Corp. (NYSE: LMT)
Vertex Pharmaceuticals Inc. (NASDAQ: VRTX)
Now, each of these stocks carry a pretty hefty price tag. All are trading anywhere from $230 to $1,320, so buying them would be too expensive to fit into our trading rules.
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Given that we'll be in these trades for a little over a week, there's no need to dance with the stock. Buying options are dramatically cheaper and generally magnify stock returns by 10.
For example, let's take a look at Chipotle. Over the course of the 2019 Santa Claus Rally, CMG gained 4.4%, while the broader S&P 500 notched just 0.7%.
Based on historical data like this, Chipotle makes an ideal candidate to play the 2020 Santa Claus Rally.
As I type this, a CMG two-week $1,295 call option is trading at $34 per share controlled. For one contract, that's $3,400. So, instead of investing $129,500 to buy 100 shares of CMG at $1,295, you'd only need to spend $3,400 for the call option.
Of course, this is dramatically lower, but it gets even better - we can reduce the cost even more dramatically using spreads. All you have to do is sell a higher-priced call option in addition to the call you bought.
Selling a CMG two-week $1,305 call will bring in $30 - or $3,000 for one contract - reducing our price per contract to a mere $400.
Now you're talking cheap! And our maximum profit for the spread is $6, or $600 per contract - that's 150% of your entry price!
So look at that - if CMG is above $1,305 in two weeks, you'll net a 150% return - with the new year just over one week old.
Now I'll leave a little something special in your stocking. Come Dec. 28, all you have to do, on any or all of the stocks I listed up above, is this:
Buy a Jan. 8, 2021 out-of-the-money (OTM) call option (a strike or two higher than stock price).
Sell a Jan. 8, 2021 call option 10 points higher than bought strike.
Close the call spread at the close of market on Jan. 5, 2021.
As always, you want to manage your portfolio and keep track of your trades. There are events that could drop the market during what is usually a bullish time, so exercise caution. Use stop losses on positions after they lose 50%.
I certainly hope these Santa Claus Rally plays light up your holidays; they always bring a smile to my face.
But the truth is, the Santa Claus Rally isn't the only regular market movement. In fact, the strategy I can share with you could potentially see you double up by Dec. 25.
About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.