Stock Option Trading News

January Effect – Stock Trading Insurance

In a previous article, “Portfolio Management: Stock Insurance”, we explained how to insure a position or portfolio of positions against a large loss by using protective put options. In article, “January Effect – Part 2”, we explained the theory behind The January Effect. Basically, The January Effect is theorized to be a result of investors selling loser stocks in order to realize tax losses near the end of a year. After the loser stocks have been depressed from the tax loss selling and the selling of the loser stocks subsides, the prices of the stocks begin to recover after the start of a new year.

We developed a strategy to take advantage of The January Effect, purchasing abnormally depressed stocks at the beginning of January and then selling them at the end of January. We back tested applying the strategy for 2005 selecting positions in January of 2006 and the results of the back test are shown below:

January Effect Backtest for January 2006
SRT 12.8
NGPS 21.2
DECK 15.6
CKEC -9.7

Back Testing Analysis:
For January of 2006, The January Effect strategy generated a very nice average return of 10% in one month with a success rate of 75%.

We applied The January Effect strategy using the same search criteria for 2006 as was used for 2005 and determined two attractive January Effect candidates for January 2007 with protective put options (stock insurance) to protect each position in the event a stock price significantly drops.

January Effect Candidates for 2007
ASPM 18.82 UCUMW 17.5 JAN 07 0.30
BCSI 23.97 IYUMX 22.5 JAN 07 0.35

Positions for 2007 Analysis:
An investor could simply buy-and-hold each of these positions and potentially make a substantial profit, but put options provide an investor the ability to make a potential profit and also have some protection in the event a position makes a contrary move.

The cost for each protective put position represents about 1.5% of the invested amount and limits the loss of each position at around 8%. For example, for 2005, if put options were available for CKEC the loss for CKEC could probably have been limited to around 8% instead of 9.7%, not much difference. But suppose the loss for CKEC has been 50% instead of 9.7%, a protective put option would have been well worth the 1.5% cost for the put option insurance.

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[tags]investment strategy, iron condor, poweroptions, stock insurance, stock option trading, stock options, the january effect [/tags]

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