The January Effect – Idea for Nov 2019

Based off the posts from Part 1, the time has come to implement the bullish call for Nov and Dec.

TLDR: Buy 1-month 310 Calls  - you can't beat the index but you can get better Sharpe

One way to do this is to buy calls, especially since now VIX is quite low. The question is which strike to buy? Buying deeper ITM would cost us a lot, but knowing that Nov isn't a particularly high-skew month also means that many OTM calls would likely end up worthless.

Profiling the equity curve of a hypothetical backtest would help. Here the option prices for each strike is taken and simulated through all the years of % change to obtain the option portfolio equity curve. It takes into account the premium paid.

Naturally, the lower the strike, the more it resembles an outright investment in SPY. Further OTM calls have an equity curve that is highly dependent on very good years, but minorly decline in most years.

A very crude way to evaluate this balance of a smoother equity vs lower total profits is the good old Sharpe ratio. The current price of SPY is 306, and the optimal Sharpe is at 309, just at 1% above current price.

Of course, lots of historical assumptions are inbuilt, but at least it's an answer and a starting point.

Reconstructed equity curves for each strike vs SPY equity (in price points)