Santa Claus Rally 2023: A Guide to Options Trading and Seasonality

The Santa Claus Rally is a well-known phenomenon in the financial world, where the stock market tends to experience a surge in the last few weeks of December. This rally has been observed in the US stock market since the 1960s.

Historically, the Santa Claus Rally has been a reliable trend, with the S&P 500 index averaging a gain of 1.3% during the week between Christmas and New Year's Day.

The Santa Claus Rally is a phenomenon where stock markets tend to have higher returns during the month of December, typically attributed to seasonal factors like increased consumer spending and year-end bonuses.

This trend is also known as the "December Effect" and has been observed by Yale Hirsch, who noticed that stock prices tend to rise in December.

History suggests that investing in stocks at the end of November and holding until just after the new year could lead to higher returns than at other times of the year.

The Santa Claus indicator looks at market performance over a seven-day trading period, the last five trading days of the current trading year and the first two trading days of the New Year.

The stats are compelling: the stock market has risen 1.3% on average during this period since 1950 and 1969, and stock prices have historically risen 76% of the time.

Professional managers tend to "window dress" portfolios for year-end reporting purposes, and many professional funds make year-end distributions, which can lead to a need to rebalance portfolios.

The "sweet spot" for the Santa Claus Rally is between the 10 and 17 trading days, which in most cases falls within a day or two of Christmas.

The Santa Claus rally is a phenomenon where the stock market tends to perform well in the last week of the year and the first two weeks of the new year.

Many experts point to the significant reinvestment of money into the market on January 1st as a major factor in this rally. This is because when the market has been up, there's a lot of money that's been made and is looking to be reinvested.

The options market also plays a crucial role, with December OPEX being the biggest option expiration period of the year. This means that a dramatic amount of flow comes into the market on January 1st, which can contribute to the rally.

The Santa Claus rally is a real phenomenon, and it's not just a coincidence. The end of the year and beginning of the year are incredibly positive, with a significant amount of reinvestment that goes into the market on January 1st.

In fact, the last week or so of the year and the first two weeks of the year are often the strongest periods of the year, with both a high percentage of years being positive and a large size of gains.

One reason for this is the dramatic amount of flow coming into the market on January 1st, which entities know about. This creates a self-fulfilling prophecy, where investors expect the market to be strong and therefore drive it up.

Trading volume is typically much lower between Christmas and New Year's, about 30% lower than any other time during the year, which means there's less resistance for markets to move. This is because there are fewer calendar days and less trading happens during this time.

The biggest option expiration period of the year is December OPEX, which can also contribute to the Santa Claus rally. Additionally, the January OPEX plays a key role in the market dynamics during this time.

Options traders can capitalize on these historical trends by considering the end of year/beginning of year money flow, market liquidity, and options volume. By understanding these factors, you can make more informed trading decisions and potentially profit from the Santa Claus rally.

Investors may have front run the year-end rally, considering the S&P 500 rallied nearly 9% in November.

The substantial November advance raises the question of whether anyone is left to buy, with a 24% chance that stock prices won't climb.

The Federal Reserve's signaled end to its rate hiking campaign gave bulls an early "Santa Claus" gift, but nothing is guaranteed.

In 2018, investors received a lump of coal, with the market declining steeply from September to December.

Similarly, in 2020, the market had a different outcome, but it's essential to remember that nothing is guaranteed.

The resurgence in bullish sentiment this year is quite astonishing, considering the 10% decline from August to October sent investor sentiment to bearish levels.

The market has been on a roll lately, but it's essential to remember that even the longest bull markets eventually come to an end. Last year's correction came just a month after we predicted it would, and the same could happen this year.

The current rally is exceptionally extended, and corrective or consolidative action is necessary to prevent a more significant downturn. Historically, volatility tends to contract at the end of December, paving the way for predictable year-end gains.

The jobs report yesterday was weak across the board, which will likely keep the Federal Reserve on hold for now. A hot CPI report or a "hawkish message" from the Fed could cause stocks to stumble, especially with volatility at extremely low levels.

Historical data suggests that December has been a good month for the stock market. Since 1950, December has had positive returns 75% of the time.

The S&P 500 has an average monthly gain of 1.6% when the market was up year-to-date heading into the final month. This is a promising sign for investors.

After a strong November, the market tends to continue its upward trend. The S&P 500 has an average monthly gain of 1.8% after months finishing higher 8% or more.

The final stretch of the year is also a good time to invest. The stock market typically experiences positive returns during the last five trading days of December and the first two trading days of January, averaging a 1.3% gain since 1970.

The market's recent rally has been quite impressive, but signs of buyers fading are emerging. The current overbought conditions on a relative strength basis are a major concern.

Historically, November's strong gains have not been followed by similar performances in December. In fact, previous years have shown that December tends to be a less successful month for the market.

The surge in corporate stock buybacks in November and December was a significant driver of the market's gains, but that window has now closed, eliminating a key buyer of equities. This could lead to a reversal in the market's trend.

The Federal Reserve's next meeting is on the horizon, and a hot CPI report or a hawkish message could cause stocks to stumble. With volatility at extremely low levels, a correction is probable.

Inflows into equity funds have been waning as we head into year-end, which could further contribute to a market correction.

The Santa Claus rally is a real phenomenon, and historical data suggests it's likely to happen again in 2023. Since 1950, December has had positive returns 75% of the time, with an average gain of 1.6% when the market was up year-to-date heading into the final month.

Volatility has been extremely low since the late October sell-off, but the market bounced sharply. The stock market typically experiences positive returns during the last five trading days of December and the first two trading days of January, averaging a 1.3% gain since 1970.

The current rally is exceptionally extended, and corrective or consolidative action is necessary. However, the combination of overbought conditions and excess bullish sentiment limited gains from weaker-than-expected economic reports, keeping the Federal Reserve at bay next week.

The "January Effect" suggests that the market's performance in January predicts how stocks will behave for the rest of the year.

About 85% of the time, if January is positive, the calendar year is also positive. This is based on data from the S&P 500, which has posted 60 positive Januarys since 1926.

However, a negative January only results in a down year about 45% of the time. This means that a bad start to the year doesn't necessarily mean it will be a bad year overall.

Stocks have risen during 73% of complete calendar years since 1926, regardless of January performance. This suggests that the market's overall trend is more important than any single month's performance.

Most sectors and markets are trading within their respective monthly ranges, with the exception of transportation, small-capitalization stocks, and bonds, which are overbought.

The risk range is a function of the month-end closing price and the "beta" of the sector or market, with ranges resetting on the 1st of each month.

Transportation, small-capitalization stocks, and bonds are the ones that are currently overbought, according to the sector model analysis.

A bullish bias to the market has been present lately, but many sectors and markets are still trading with bearish moving average crossovers on a weekly basis.

The return of a long-term trending bull market will be signified by a reversal of those crossovers, which is currently not the case.

Here is a breakdown of the current risk ranges for each sector:

It's essential to use corrective pullbacks to add exposure as needed, considering the markets are technically stretched.

The S&P 500 has historically risen by a monthly average of 1.5% in December since 1950, and even higher at 2% over the last decade.

Corrective action is necessary in the current rally, as it's exceptionally extended and overbought conditions are extreme.

The market has struggled to advance early in the week, but climbed to set new closing highs on Thursday and Friday.

Historically, volatility tends to contract at the end of December, paving the way for predictable year-end gains.

The jobs report was weak across the board, which will likely keep the Federal Reserve on hold for now, and next week is the inflation report and the last FOMC meeting for the year.

A hot CPI report or a "hawkish message" from the Fed could cause stocks to stumble, given the extremely low levels of volatility.