Sell in May and Go Away—Not Good for Taxable Accounts

Tuesday, May 6th, 2014 | Vance Harwood

When I first saw a chart similar to the one below in Business Insider I was immediately suspicious.  For example I knew that May through September of 2009 was a period of rapid growth (21%) yet that surge did not seem to show up on the bottom curve (green)—which shows the performance of staying in the market only May through September.  

SIM 20yr-no-tax

It turns out the 21% gain is there, it’s just on such a low basis ($815), that it’s dwarfed by the other curves on the chart (one of the dangers of a chart with linear vertical axis).

My analysis didn’t include dividends nor did I factor in interest that could have been earned while out of the market.  I think these two factors would roughly offset each other with the in/out strategies, and including dividends would have boosted the gains of the “always in” strategy.

I also wondered about the choice of 1994 as a starting point.   A 20 year time frame is reasonable, and 1994 wasn’t a particularly eventful year, but I repeated the analysis with 63 years of S&P 500 data to see if it made a difference.

SIM 50yr-no-tax

Over this timespan the “Sell in May” strategy significantly lagged in the bull markets of the late nineties and 2002 to 2007, and catches up during the depths of the bear markets.

The hold May through September strategy is still a flat-liner.  It’s hard to see how being in the market during that period helps the buy & hold strategy.  A closer look at the yearly distributions yields the answer.

The chart below shows the distribution of the percentage gains/losses by year being invested only May through September.

SIM 50yr-rtns-IMS

The average of all the returns is low—a paltry 0.33% yearly gain, but the number of up years out numbers the down years by almost two to one, 40 up years vs 23 down years.

The next chart adds the results (green bars) of being invested except for May through September.

SIM 50yr-rtns-both

 There were only 10 years during this 63 year period where losses during the May through September period weren’t more than offset by the returns from the rest of the year.  And in 33 of those years both periods had gains—dramatically compounding the results.   It’s this compounding effect that rewards the buy and hold investors.

This final chart shows the performance of the “Sell in May and Go Away” strategy with taxes included, assuming a 28% marginal tax rate.

SIM 50yr-w-tax

Since the strategy is never invested for a full year taxes on profits will always be at short term capital gains rates—typically the same as your marginal tax on income.   Since you don’t have to pay taxes on gains until the year after you sell the security I assumed that the money earmarked to pay taxes was used for ongoing investment until early April of the next year.  Losses were carried forward and used to reduce/ eliminate tax on latter gains.

Including taxes the results of the 63 year “Sell in May” strategy were hammered down 70%—from $100K down to $30K and the 20 year period takes a 30% haircut.  So, unless your investments are in a tax protected account the historical performance of this strategy would have been abysmal.   Even in non-taxable accounts the long term performance of “Sell in May” would have been inferior.

I think it’s best to stay away from “Sell in May”.

Modified Davis Method Moves to 50% Cash

Sunday, April 13th, 2014 | Vance Harwood

The market stumble the end of last week dropped the Russell 2000 enough for Frank Roellinger’s Modified Davis Method to signal a 50% sell.  That portion of the portfolio gained 17.6% since being opened 30-November-2012.  This exit was foreshadowed in the Modified David Method-March 2014 Update 

The other half of the portfolio, initiated in July 2009,  is still long with a 57% open gain—market breadth has not diverged enough to trigger an exit.  

Related Posts

  • Guest Post: Modified Davis Method—March 2014 Update, by Frank Roellinger
  • Guest Post: The Modified Davis Method, by Frank Roellinger

Thirteen Things You Should Know About Trading VXST options

Thursday, April 10th, 2014 | Vance Harwood

If you want to trade options on VXST I’ve listed some things below that you should know.  If you are interested in other volatility investments besides options see “10 Top Questions About Volatility“.

 Regarding VXST options:

  1. Your brokerage account needs to be a margin account, and you need to sign up for options trading.   There are various levels of option trading available (e.g., the first level allows covered calls).  My experience is that to trade VXST options you will need to be authorized to trade at the second level.  These levels vary from brokerage to brokerage, so you will have to ask what is required for  long or spread positions in VXST options.   If you are just getting into options trading this is as high as you want to go anyway. Selling naked calls for example is not something for a rookie to try.
  2. No special permissions are required from your broker for VXST options. In general the same sort of restrictions (e.g., selling naked calls) that apply to your equity option trading will apply here.
  3. Calendar spreads aren’t allowed (at least within my account, with my level of trading). The software might not prevent entering the order, but the order will be cancelled once your broker’s software gets around to analyzing the order.   The reason for this restriction is because the options from different months don’t track each other well. More on that later.
  4. The option greeks  for VXST options (e.g. Implied Volatility, Delta, Gamma) shown  by most brokers are wrong (LIVEVOL and Fidelity are notable exceptions).  Most options chains that brokers provide assume the VXST index is the underlying security for the options, in reality the appropriate volatility future contract is the underlying. (e.g., the options expiring the second week of April have the second week of April VXST futures as the underlying).   For instructions on how to get VXST futures quotes go this this post.   To compute the correct greeks yourself go to this post.
  5. Because the underlying for VXST options is the futures contract, the options prices do not track the VXST particularly well.  A big spike on the VXST will be underrepresented, and likewise a big drop probably will not be closely tracked.   This is huge deal. It is very frustrating to predict the behavior of the market, and not be able to cash in on it.  The good news is that with the VXST shorter expectation horizon (9 days) at least we have something more responsive that VIX futures / options. The only time the VXST options and VXST are guaranteed to sort-of match is on the morning of expiration—and even then they can be different by a couple of percent.
  6. The VXST options are European exercise. That means you can’t exercise them until the day they expire. There is no effective limit on how much VXST options prices can differ from the VXST index until the exercise day.
  7. Expiring In-the-Money VXST options give a cash payout.  The payout is determined by the difference between the strike price and the SVRO quotation on the expiration day.  For example the payout would be $1.42 if the strike price of your call option was $15 and the SVRO was $16.42.
  8. The expiration or “print” amount when VXST options expire is given under the ^SVRO symbol (Yahoo) or $SVRO (Schwab).   This is the expiration value, not the opening cash VXST on the Wednesday morning of expiration.  VXST options expire at market open on expiration day, so they are not tradeable on that day.
  9. VXST options do not expire on the same days as equity options. It is almost always on a Wednesday before or after the Friday equity option expiration date.   This odd timing is driven by the needs of a straightforward settlement process.  On the expiration Wednesday the only SPX options used in the VXST calculation are the SPX weeklies that expire in exactly 9 days.  For more on this process see Calculating the VIX—the easy part.
  10. The bid-ask spreads on VXSToptions will tend to be wide .   You should be able to do better than the posted bid/ask prices.  Always use limit orders.  If you have time start halfway between the bid-ask and increment your way towards the more expensive side for you.
  11. I don’t recommend you start trading options on VXST if you aren’t an experienced option trader. If you are a newbie trade something sane like SPY options first…
  12. The VXST is not like a stock, it naturally declines from peaks. This means its IV will always decline over time. VXST options as a result will sometimes have lower IVs for longer term options—not something you see often with equities.
  13. The CBOE reports that trading hours are: 7:30am to 4:15pm Eastern time, but in reality the options do not trade until after the first VXST “print”-when the VIX value in calculated from the first SPX options transactions. The first VXST quote of the day is usually at least a minute after opening.


Guest Post: Modified Davis Method—March 2014 Update, by Frank Roellinger

Saturday, March 29th, 2014 | Vance Harwood

It’s been about 7 months since my first article on The Modified Davis Method appeared, so it’s time for an update.  Here is the original chart updated through 3/28/14.  As before, the top (white) line is the method’s results; the yellow line is the Value Line/Russell 2000 series; the green line is the S&P 500 for reference.


The method is still 100% long after the last buy on 11/30/12 when the Russell 2000 closed at 821.92.  Since then the ETF that tracks the Russell 2000 (IWM) is up more than 42% with dividends reinvested.

The following chart illustrates the method’s computed potential exit points since the Buy on 11/30/12.  The upper line is the weekly close of the Russell 2000 index; the lower line depicts the exit points each week.  The method has remained 100% long in the Russell 2000, despite several pullbacks and the usual plethora of predictions that the market is overvalued and cannot go much higher.


Additionally, the original 4% method would have exited and reentered 3 times during this rally, greatly reducing the gain compared to remaining 100% long.  Searching for thresholds other than 4% and employing the dynamically-adjusted trend line have payed off handsomely this time.

The stop was just barely missed on 02/07/14.  Since then, the stop has risen more than 23 points and is still rising.  The method’s use of breadth suggests that the final top has not been reached.  But, sooner or later an exit point will be breached, and soon thereafter, it will be reported here.

Related Posts

Contango Takes A Breather

Wednesday, March 26th, 2014 | Vance Harwood

VXX hasn’t hit a new low in 6 weeks, and it’s not because the market is crashing.   What has changed is the shape of the VIX futures term structure—the underlying futures that the various volatility Exchange Traded Products (ETP) like VXX, XIV, TVIX, and ZIV are based on (see volatility tickers for the entire list).

For most of 2009 through 2012 the monthly roll cost between the two front month VIX futures used by VXX averaged around 10% when the market was flat or rising (in contango).  In 2013 this average cost dropped to around 5% and is headed even lower in 2014.


The monthly roll costs of the longer term VIX futures used by VXZ and ZIV have been declining also, dropping from  historic 5%+ highs during 2012 to average slightly above 2% in 2013 and 2014.


This change was driven by a flattening of the VIX Futures term structure.   In spite of the front month’s future being about the same value, the later dated futures values have dropped considerably since early 2013.


Why has the curve shifted?

First of all it’s important to remember that VIX futures are ultimately tied to the prices of SPX options of the appropriate month (e.g., August VIX futures are settled to September SPX options).  So the real driver is the much larger SPX options market.   Not surprising the SPX options premiums have shown the same shift in term structure over this timeframe.


I think this big shift in longer dated volatility is due to two factors:

  1. A lot of people have taken short volatility positions in the last year and a half
  2. Traders are less concerned about volatility spikes in general, so they are paying less for longer term “insurance” via SPX options and VIX futures

Both of these factors would tend to depress longer term SPX option prices—and VIX futures prices.   It’s possible that this trend will continue, leading to the flattened term structure we saw in 2007 and early 2008 —at the end of the last bull market. But I doubt it; instead I expect the term structure to stabilize until we see another real VIX spike (into the 40’s).

Coincident with the drop in contango, there has been a leveling off of the open interest in VIX futures.  I don’t think either of these changes caused the other—but perhaps I’m missing a linkage.




Up until 2013 the open interest had been growing 40% per year, but since then the shorter term open interest has stabilized and the medium term open interest has pulled back around 20%.   VIX futures volume on the other hand has continued to set records.  Volatility ETP asset growth was a big driver in VIX futures starting in 2009, but currently the total assets in those funds have hit a plateau.

VXX will probably set some new lows in the next month or two, but expect it to moderate its losing ways for a while.