2 Leveraged Strategies To Play 'Sell In May And Go Away'

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 |  Includes: SH, SSO
by: Tiger Technologies

Summary

Prevailing wisdom in the markets is to sell stocks and stay out of the markets from May through October to avoid periods of low returns and high volatility.

Our analysis confirms that May through October returns in the S&P 500 are indeed significantly worse than those from November through April.

But simply going away in May does not create a profitable strategy. A better way to take advantage of this is through these 2 leveraged strategies.

The axiom, "sell in May and go away" is well accepted in the investor community. It states that, if an investor were to sell their stock holdings by the end of April and re-enter at the start of November, they would avoid a lot of gut wrenching losses and volatility that has been historically seen in the stock market.

We wanted to test this postulate for ourselves and see if our analysis showed a significant disparity in returns and, more importantly, if there was anything else that might be useful from a trading perspective. We looked at the S&P 500 data from 1953 to 2013 and compared the returns for the entire year, versus the period from May through October and November through April. Additionally, we did not take any dividends into account and just wanted to see the pure price effect of the stocks in the S&P 500 index. This is what we found:

Source: Tiger Technologies, Yahoo Finance

Quite clearly, looking at the summary of the findings from 1953-2013, we see that:

  • The period from November through April produces higher median (by a factor of 3) and higher average returns (by a factor of 5) over the period from May through October.
  • The worst year from November through April invested period is -19.6% versus -31% for the period from May through October.
  • The skew of the distribution of those returns is far more negative for the May through October period than the November through April period. Investing only in November through April produces more positive months, as well as more positive years.

The chart below shows the outperformance of the November through April period over the May through October period. The trend of outperformance also seems consistent over the years and does not exhibit any changing behavior.

Click to enlarge

Source: Tiger Technologies, Yahoo Finance

Trading Strategies

Given the strength of the trend there are a couple of trading strategies that can be utilized for beating the S&P 500 over a period of time.

1. Invest 100% from November through April and 0% from May through October. While this strategy will produce more consistent returns as measured in terms of percentage of positive months and lower losses, the absolute level of returns is lower. As shown in the table above, the average annual returns of holding over the entire year are 8.2%, while the average annual returns of holding from November through April are only 6.9%. Additionally, there are transaction costs and tax consequences, which would lower the returns even further.

2. An alternative approach might be to leverage your investment (2x) from November through April and then go to the sideline during the May through October period. This strategy produces returns that are significantly higher than the entire year's returns and the worst loss is no worse than the entire year's either. (Leveraged Strategy I in the chart below).

3. A third strategy would be to leverage your investment (2x) from November through April and then short the market during the May through October period. This strategy also produces returns that are significantly higher than the entire year's returns and the worst loss is no worse than the entire year's either. (Leveraged Strategy II in the chart below).

Source: Tiger Technologies, Yahoo Finance

Leveraged strategies can be established in several ways, but it is best to implement them on the S&P 500 index rather than on individual stocks. One way is to use leveraged long ETFs like the ProShares Ultra S&P 500 (SSO) for the long exposure from November through April and an inverse ETF like the ProShares Short S&P 500 (SH) from May to October.

A better way to utilize leverage and to go short is through futures. Trading futures on the S&P 500, e.g. the e-mini futures contracts, is cheaper and cleaner than using ETFs because the risk of slippage is minimal and transaction costs are usually very small as well.

Please bear in mind that all uses of leverage enhance investor risk when compared to unlevered buying or selling, so an investor should seek advice suited to their individual needs.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Tiger Technologies, LLC unless a client service agreement is in place. Nothing in this presentation should be construed as a solicitation or offer, or recommendation, to buy or sell any security, or as an offer by Tiger Technologies, LLC to provide advisory services. Investment management services are offered only pursuant to a written Customer Agreement, which investors are urged to read and carefully consider in determining whether such agreement is suitable for their individual facts and circumstances.