Wednesday, December 16, 2009

The Debts of the Spenders: Santa Rally and TED

The January Effect/aka Santa Rally is a seasonal effect marked by low volatility and light volume. The dearth of active trading days make for a time when fund managers try to lock in their gains for the calendar year by selling their winners and dumping their losers (for various tax related reasons). The market bias has historically been bullish but here is something that traders might want to pay attention to: the TED spread.

In a low interest rate, weak dollar environment it is easy to fall into the trap of thinking that markets will continue trending higher. But watch for sharp corrections. Clues can be found in the money markets.

For recent history, traders should be aware of the early November high of .262 as well as the September lows of .163. Personally, if the market returns to a test of September lows, I will view that as a contrarian signal and buy some protection against volatility in the form of stock puts or Vix calls.
Adventurous traders can try to time a return to bullishness if they believe the market is due to continue its ascent higher by going long Vix puts at a re-test of the November high.

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