According to the Stock Trader's Almanac 2012, investors who kept their money in the Dow Jones Industrial Average (NYSEARCA:DIA) or S&P (NYSEARCA:SPY) from November 1 through April 30 and removed their money from the markets from May 1 through October 31 each year since 1950 would have realized returns in excess of simply staying fully invested year round.
Starting with $10,000 on November 1, 1950, an investment only during the November 1 through April 30 time period each year would have grown to $619,071 by April 30, 2011. A $10,000 investment in the market from May 1 through October 31, beginning in 1950 and repeating each year, would have actually declined to $9,621.
While this "Six-Month Switching Strategy" is not breaking news to all investors, what I will propose doing with the money during the six months it is not invested in the Dow or S&P is different from what Jeffrey and Yale Hirsch discuss in their strategy. The Almanac mentions taking your funds and investing them in "fixed income" for the May 1 through October 31 time frame. While it wouldn't be difficult to buy a six month CD, continually roll over ultra-short-term T-Bills, or place the money in a "high yield" FDIC insured bank account, given how low interest rates are in today's world of ZIRP (zero interest rate policy), another possibility is to sell puts on SPY or DIA.
Specifically, an investor wanting to execute this strategy with the least amount of effort would want to take a look at the September DIA and SPY options (no October options are currently available). There are many different ways to approach this depending on how aggressive you want to be. When thinking through which strike price(s) to sell, it may be useful to know that going back to 1950, during the May through October time frame, there were 37 years the Dow finished up versus 24 years it finished down. There were just two years the Dow was down more than 20% and no years in which the declines topped 30%.
Below is a table outlining some of the current out-of-the-money September 22, 2012 strike prices and bids for DIA as well as the return on investment (ex-commissions) for the roughly four-and-a-half month investment:
DIA Sept. 22, 2012 Put Options
These strike prices range from 12.18% out-of-the-money to 27.45% out-of-the-money. Keep in mind that the goal is not to get an amazing return on your investment. It's simply to get something better than what you can get in ultra-short-term securities. Also, it should be noted that all these strike prices have spreads that would cause me to search for hidden liquidity rather than simply accepting the bid. For example, the $107 strike price has a bid/ask of $0.92/$1.03. If I were selling those puts, I would not simply sell the bid but instead would search for hidden liquidity starting at $0.97 and work my way down to $0.92 in penny increments.
Now, let's take a look at a table outlining some of the current out-of-the-money September 22, 2012 strike prices and bids for SPY as well as the return on investment (ex-commissions) for the roughly four-and-a-half month investment:
SPY Sept. 22, 2012 Put Options
These strike prices range from 13.23% out-of-the-money to 27.69% out-of-the-money. As I mentioned with regard to DIA, if you think the bid/ask spread is too wide, it might be worth searching for hidden liquidity before simply accepting the displayed bid. Also, remember that if you want to compare the returns in the tables to fixed income investments you might make, the yields presented to you on the fixed income opportunities are most likely annualized whereas the yields in these tables are not. Annualizing the yields in the tables above would, of course, make the returns appear much better.
Furthermore, if you think it is more prudent to sit in cash and wait for a better entry point to sell puts (higher implied volatility levels and/or lower equity prices), that strategy can work as well. Also, although it wouldn't be my cup of tea, you could consider selling puts closer to at-the-money if that is in line with your risk tolerance and goals. I would simply caution that if you do get assigned on the puts, it could detract from your ability to properly execute the strategy during the November 1 through April 30 time frame. So, choose your strike price wisely.
I would like to also mention one issue I have with the strategy outlined by the Almanac. From what I can tell, it doesn't take into account the tax effect of selling on April 30 each year versus holding an investment year round. Given that every investor's tax situation is different, it would be nearly impossible to say with certainty how an investment in a taxable account following the Stock Trader's Almanac's strategy would have fared over time. However, if you have the ability to invest in a retirement account with a tax friendly structure and you believe in the seasonality of financial markets, then this strategy will likely be quite enticing to you.
In addition, the 2012 Almanac offers a timing strategy using the MACD technical indicator that enhances the return in a major way. It increases the November through April investment from $10,000 to $1,591,034 while reducing the $10,000 invested during the May through October time frame each year to just $3,617. For more information on this strategy or for a whole host of other great information, consider purchasing the Stock Trader's Almanac 2012 by Jeffrey A. Hirsch and Yale Hirsch.
Two final notes: It is important to mention that the S&P 500 has only existed in its present form since 1957. Before March 4, 1957, the S&P index consisted of fewer companies. In the Stock Trader's Almanac 2012 page referencing this strategy, the authors do not refer to the S&P 500 when mentioning the performance, but rather they refer to the "S&P."
Second, despite the fact that we are now four trading days into May, it is not too late to execute the strategy. Remember that in the 61 years this strategy has been in existence, the market has finished lower 24 times, and of those 24 times, stocks finished lower by more than 1.8% 22 times. In other words, despite this May's slight pullback for the Dow (down 0.68%) and S&P 500 (down 1.10%), if this is to be one of those tough May through October time periods, it's not too late to sell. Also, if this isn't set to be one of those tough May through October time periods, which, of course, nobody knows for sure, then look at the slight pullback as having provided you the opportunity to sell puts for a greater premium.