January 10th, 2022

This Early Warning System Just Flashed A Signal

After the year we had in 2022, everyone wants some indication that this year will be better. So we start comparing where we are now with previous years to see if we can predict where we might be headed.

Yale Hirsch developed the January Barometer in 1972 by looking at the first five trading days of January and then looking at the return for the month of January to see if he could predict how the rest of the year would perform.

The indicator is supersized if we have a greater than 2% return in the first five trading days of the year. With yesterday’s fall, that didn’t happen, but the first five days did finish in positive territory and that’s still a good sign.

The last 46 times the Early Warning System showed positive returns, the full year for the S&P 500 was positive 38 times, 82.6%, with an average gain of 14.3%.

Ok, so we’ve cleared the Early Warning System, so now it’s on to see what the rest of January will look like.

Since 1950, if January was positive the full year was positive 85.7% of the time with average gains of 17.6%.

Keep in mind that the market has a bullish bias and there are other months and 5-day periods that are more correlated with positive yearly returns, but I understand why everyone looks to January as hope for the future. No one is going to wait to see how April does before they start investing for the year, even though April has been more correlated with yearly returns in the last decade.

With this week’s CPI report and Jobless claims report, we will see where the market wants to go. Just remember the ongoing themes – recession, stubborn inflation, higher interest rates, etc. We may get a bump higher here and there, but there are plenty of hurdles left to go before we are out of the bear market.

Today’s trade idea is a simple options credit spread for income trade on Microsoft (MSFT). This particular trade has worked well for me, but of course, results can always change, and past performance doesn’t guarantee future results. This is a strategy that is currently under development, but I’ve been forward testing this to compare it against backtested results.

A bull put credit spread involves selling a put closer to the current price and buying a put further away from the current price. The result is a net credit for income we receive for placing the trade. Over time, and if the stock moves up, the put credit spread loses value, and we are able to buy it back for less than the credit we initially received.

Unlike what I normally coach in Options Testing Lab, I’m going out 102 days on this trade, out to the April (23) expirations. The current price is $227 and I’m able to sell a bull put credit spread by selling the $190 put and buying the $165 put for a net credit of $2.27.

credit spread for income

Microsoft is bouncing off a support line and has been trading mostly flat for the last few months. I’m looking for MSFT to remain flat or head higher from here. The trade can still be successful if MSFT heads lower, as long as it remains above 190 at expiration.

-1 MSFT 21 APR 23 190 put
+1 MSFT 21 APR 23 165 put
Net Credit: 2.27 ($227 per spread)
Buying Power Needed: $2273 to place the trade

Profit target: 60%
Place GTC order: 0.90 (0.4 * 2.27 credit received)

If we buy back the spread for 0.90, we make 1.37 in profit (2.27 – 0.90). That 1.37 in profit would be a 6% return on buying power risk for the trade.

The average time in a trade like this is about 35 days, but a 6% return in 35 days is over 70% annualized.

I’m working on the backtest for this strategy and so far the largest loss I’ve come across going back 5 years was $593 per spread and that occurred in November of 2022.

What do you think? Is a bull put credit spread the best options strategy here?

If you have any questions, comments, or anything we can help with, reach us at any time.
Email: [email protected]
Phone: (866) 257-3008

Jeff Wood

Editor, Filthy Rich Dirt Poor

Trader, Options Testing Lab

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