April 25, 2022

Mid-Term Election Slumps

The market on Friday was enough to make anyone want to walk away and take a break unless you were on the correct side of the market meltdown.

 

Well, remember 2018? President Trump was enjoying a soaring stock market from 2016 to 2018, but then it hit a wall in 2018 – at one point it gave up 18.8% of its gains. The Dow rose under the initial term of President Biden, but once again it’s hit a wall, giving up more than 12% this year.

 

If you’re a fan of the concept of seasonality in the stock market, this table tells us that there’s potential for better times ahead.

 

Median Annualized Stock Market Returns Per Presidential Year

(1900 – 2021)

Prior to an election, politicians will use every available lever at their disposal to stimulate the economy, which is why, some theorize, the first year after an election has better returns than the second.  The first half of year two is uncertain and more about governing and starting the battle for mid-term elections.  It introduces uncertainty into the market.

 

The second half of year two tends to be a bit stronger, relatively speaking, as politicians will once again do what they can to contribute to strong stock market returns in the hopes of re-election.  Once the uncertainty of congressional elections is sorted out, Wall Street can move forward in year three.

 

This year we’ve been hit with a myriad of things from inflation, interest rate hikes, pandemic exhaustion, supply chain issues, and a war in Ukraine.  I’m not so sure we’ll bounce back and see any gain this year, but I certainly wouldn’t mind a bit of a second-half rally.  

 

We’ve already started to see the state of the economy as a talking point for the upcoming elections.  Will that be enough to drive some sort of near-term rally?

 

 

MARKETS

Unless you were net bearish last week, there wasn’t much that you could do.  Real Estate was the lone positive sector.  Even the cryptos struggled last week.  But one week does not make a market.  Consumer Defensive, Real Estate, and Utilities are still strong on the 1-month and 3-months charts.

TRADING EDUCATION

We’re going to get into user-submission questions this week, but first, we’re going to start off the week by talking about calendar spreads.  A calendar spread is entered by simultaneously entering a long and short option position at the same strike price, but with different expiration dates.

 

In a typical calendar spread, you buy a longer-term contract and sell a shorter-term contract.

 

You are left with a risk profile that looks like a tent.  Your maximum gain occurs when the stock finishes at the strike price you selected.   This strategy makes money with the time decay of the short option or with an increase in volatility.

 

For example, the picture below shows an NVDA calendar using the following options:

Buy – May 20, 2022, $195 put @ $13.78

Sell – Apr 29, 2022, $195 put @ 7.80

 

The net debit of the position is $5.98 (debit of $13.78 minus the $7.80 credit).

 

Note that you can do this trade with calls or puts but either way you profit when the stock doesn’t move.  Unlike other strategies, entering a calendar with puts doesn’t make it a bearish strategy.  

Likewise, a calendar using calls doesn’t make it a bullish strategy.  A calendar is a delta-neutral strategy.