How To Use Options To Capitalize On Seasonal Price Patterns

When you’re trading options, you’re playing a game of probabilities because you don’t know for sure where the stock price is going.  In this example, we will go over how to use historical seasonality data to develop a probability strategy (i.e. a strategy that gives you an advantage based on the likeliness of an outcome). I want to show you how to find and make an actionable decision based on seasonal stock price patterns.

What Is Seasonality?

Seasonality is a repeating stock pattern during certain periods in time.  For instance, a stock that tends to go up more often than not over a certain calendar period. Below is an example of using historical data in the SPY exchange-traded fund to identify seasonality by calendar month. As you can see, SPY tended to perform best for the months of April and November. In those months, SPY had a positive return over 90% of the time for average gains above 2.4% (see screenshot below). 

Keep in mind, it is not possible to know for sure what a stock will do in the future. So, we try to give ourselves an edge by crunching the data and using the statistics to gauge what we think is likely to happen. Even though you should check the news and other metrics to help guide your decisions, for simplicity, let's stick with seasonal statistics only.

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How To Find The Seasonal Historical Odds

In the above example, we saw historical data for SPY by calendar month. However, maybe you need to narrow down or expand the dates for a defined time period. This is especially true if you are looking to do an option strategy that has set expiration dates. Using the MarketChameleon.com price action analysis tool, you can analyze historical dates that coincide with the dates of the option strategy expiration.

For instance, let’s say the next monthly option expiration is Dec 18, 2020. We may want to know how SPY behaved historically between November 23 and December 18. So, let’s use the historical price action analysis tool to retrieve seasonality statistics (see screenshot below). As we can see from the generated report, SPY was up 75% of the time for an average gain of 2.37% for time periods from Nov 23 to Dec 18 over the last 12 years. We can also see that the max gains vs losses for this period, +12.3% vs -3.8% respectively, favor a more positive outlook. The average moves to the upside of +3.9% exceeded the magnitude of the average downside moves of -2.3%.

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Finding Seasonal Opportunities

Since a seasonality play is an attempt to capitalize on a short term probability pattern, options can be a great way to take advantage of this strategy. Instead of searching for opportunities one stock at a time, we can use a tool that will generate a list of opportunities to pick from - In the screenshot below, you can view a Bullish seasonality scan on MarketChameleon.com to find what current stocks are showing a bullish seasonal trend and corresponding options strategies that have a statistical edge . The tedious and arduous leg work has already been done so let's interpret the results. 

In the list of stocks, you can easily see highly seasonal patterns, the corresponding calendar days of the time period, and how well, on average, the stock returns were during those time intervals. For example, in the last 10 years, the stock XLF has performed rather well during the calendar period of Nov 20 to Dec 11 (see screenshot above). The stock was up 100% of the periods for average gains of 1.9%. If history is any guidance, we would benefit from a strategy that is neutral to somewhat bullish in the next 10 days.

Picking the Right Stock

I like to make sure that I pick a stock that has a lot of option volume because the higher liquidity the better chance I have of making the trade I want. I like to see plenty of volume and tighter markets because I know I will be able to get in and out of a trade easily and at a reasonable price point. XLF is on the top of the list, but I like to see more option volume than 100,000 on average, so I'll skip that one (you can find the average option volume by going to the stock’s detail page). SPY catches my eye right away.  I know that it has plenty of option volume and I will be able to have a better chance of getting in at a reasonable price. SPY average option volume is over 4 million. My next step is to see what opportunities are out there for SPY.

Finding the Most Promising Strategy

By simply selecting the row for SPY, I can quickly see 2 promising trade ideas from a scan of hundreds if not thousands of scenarios. As you can see, the scan has boiled it down to either a Bull Put Spread or a Bull Call Spread (see screenshot below).

Picking The Option Spread

Ultimately, we are trying to maximize returns while limiting our risk. By now we know that we are hoping the seasonal pattern continues and the stock price will again go up over the current seasonal time period. In order to take advantage of this potential repeat stock behavior, we should use an option strategy that makes us money on an upside move in the stock while also limiting our downside risk. 

Even more so, we want to make a trade that can give us an additional theoretical edge and increase our odds of success. The Marketchameleon scan filtered all of this out and shows us the most promising opportunities for a vertical spread (see the Bull Call Spread trade card below) that has a statistical theoretical edge of 16.6% and a historically high success rate of 71%. The following spread consists of buying a call at the 355 Strike and selling a call at 358 strike for a total debit of $1.85. 

Since we have a bullish outlook, this spread will benefit if the stock increases from here. If the seasonal pattern holds true during this time period (from November 20th to December 18th), we can reasonably guess that SPY will go up from here above 358 (which is less than a fraction of 1% gain). If that comes to fruition, both SPY options will expire in-the-money, making the spread worth $3 (358 strike - 355 strike = $3) leaving us with a $1.15 gain ($3 - $1.85).  We will have realized a whooping 62% return on our option spread ($3.00 - $1.85) / $1.85 = 62%. 

Summing It Up

• Get a list of strong seasonal trends
• Pick stocks with very high option volume and liquidity
• Find strategies that can capitalize on the outlook
• Screen for option strategies that provide additional statistical edge to maximize your returns and minimize your risks