Buyside Strategies EQD Research Sponsored Articles
Jul 31, 2021
By Russell Rhoads, head of research
As we approached August, market observers and commentators pointed to the danger that the months of August and September may hold for stocks. This line of thinking comes from recent history. Specifically, mid-month sell-offs in the 12% to 13% range for the Nasdaq-100 (NDX) in August 2011 and August 2015 along with a 10% sell-off in September last year.
I decided to go farther back than just the past decade and see if there is a pattern of weakness over the next couple of months. The first run looks at the best, worst, and average performance along with the percent observations where NDX was higher by month from 1990 to the present.
Data Sources: Nasdaq and EQD Research Calculations
The average performance for August is a gain of 0.39% while the average performance in September is a loss of 0.10%. This average performance ranks as two of the three worst months for the NDX with February falling between them. NDX is higher 58.06% of observations in both August and September. This ranks the months higher than three other months, but still in the bottom half of performance based on this metric. Finally, the worst monthly performance does not stand out when August and September are compared to other months.
Since August and September are being grouped together as a treacherous period, I decided to look at the historical two month performance, again going back to 1990. The second table breaks down NDX historical performance over two months.
The August and September combined performance is slightly positive, but much lower than any other two-month period. The best performance for this two-month period is in line with May and June as the lowest best performance. To the downside, the worst performance over the August to September period was a loss of 30.60% in 2001. The percent of observations where NDX is higher over this two-month period is in the middle of the range compared to other pairs with four other two-month periods resulting in a gain for the NDX.
So a quick analysis shows the August to September period is not the best time to have exposure to NDX, but it is not such an outlier that traders should completely avoid owning stocks over the next two months. There are several reasons to be concerned about stocks in 2021 and if you fall in that camp a collar or short call plus bear put spread to guard against losses may make sense.
First, I priced out a collar using NDX options expiring on the last trading day of August. On Friday July 30, NDX closed just under 14960. The Aug 30th 15000 Call could be sold for 275 and Aug 30th 14900 Put purchased for 270, resulting in a credit of 5.00. The payoff of this collar, combined with a long NDX position, at option expiration appears below.
This option spread combined with owning NDX has both very limited upside and downside. Any investor or trader who is happy with their returns in 2021 may consider this an appropriate position for the following month.
If a trader is more bullish or wants more upside participation, they can always raise the call strike. This would result in taking in less premium than selling the 15000 call. If a higher strike call is sold a lower strike put could be purchased or possibly a lower strike put sold to cover the cost of a higher strike long put. This second example does just that.
Again, with NDX right at 14960, a trader could sell the Aug 30th 15200 call for 171, buy the Aug 30th 14900 put for 270 and then sell the Aug 30th 14100 put for 96 resulting in a cost of 3.00 per spread. The result for this spread combined with owning NDX appears below.
Any move below 14900 down to 14100 in the NDX is offset by the long put. The spread guards against an NDX loss of 0.40% to 5.75%. Once the 14100 price level is reached, the short put will result in the benefit from the long put being offset by the short put. Upside is now limited at about 1.5%, with gains offset by the short 15200 call.
Admittedly, there are many reasons to be concerned about the direction of the stock market over the balance of 2021. Relatively weak August and September performance may contribute to this line of thinking. If you share these concerns, the option market offers unlimited opportunities to guard against losses.