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Another Expiration Friday Surprise in Store?

September 13, 2007

Dear Fellow Options Trader,

"Sell Rosh Hashanah and buy Yom Kippur" is an old trading adage that works about as well as those levies down in New Orleans. And yet, every year traders try to see whether this will be the year that they can profit from a strategy that's less a brilliant idea than a timeworn cliche.

Some would have you believe that you should have sold (i.e., shorted) the stock market -- which, for the sake of this article, I will use the Dow Jones Industrial Average (DJI) as a surrogate for the market -- on Rosh Hashanah and bought it back on Yom Kippur. According to this "conventional wisdom," you'd have made enough money to keep Paris Hilton in bling for years.

Ha -- if only it were that easy!

NEW YEAR, BUT SAME TIRED OLD ADAGE

The theory is easy enough to understand: You short the market, or at least get out of your longs, on Rosh Hashanah (which started today) and you stay out, or short, until Yom Kippur, which is Sept. 21.

Since the celebration of the Jewish New Year began last night at sunset, you already would've been out of the markets and/or short last night. So, you'd actually be some 133 points in-the-hole today, as the Dow closed up by that many points at 13,424.88.

This said, the backtested data does not indicate that there is any real trade here that we can make money on. To wit, the folks over at MarketHistory.com noted, "The breakdown is so close to 50/50, and the variance so high as to allow us to dismiss this 'conventional wisdom' as folklore."

Fair enough -- the adage doesn't really prove true. But even if it did, it would be facing a daunting test on Tuesday, as the Federal Open Market Committee (FOMC) will meet for its September tuna sandwich and Aquafina. (Yeah, if you believe they're feasting on tuna salad and water. I've got some subprime mortgages for you at 3% with no documentation as well!)

GETTING TO THE 'POINT'

All kidding aside, at that meeting the FOMC is virtually guaranteed to make a cut in the Fed Funds rate. The only question is by how much.

The Fed Funds futures that trade at the Chicago Board of Trade (BOT) are projecting a 42% chance of a 25-basis-point rate cut (taking the target Fed Funds rate to 5%), and a 58% chance of a 50-basis-point cut (or a 4.75% Fed Funds rate).

The Federal Funds rate has been at 5.25% since June 2006, and I think the FOMC will make the smaller 25-basis-point (or, quarter-point) move and then gauge the market to see whether more of a cut is needed.

If they determine more is needed, well guess what falls on Sept. 21 -- just three days after their FOMC meeting? That's right, Yom Kippur.

But don't forget what also happens on Sept. 21 -- not only is it expiration Friday for equity options, but it is also quarterly expiration for the S&P 500 (SPX) futures and options. This phenomenon is called "quadruple witching," a predictably volatile day in which equity options, index options, index futures and stock futures come off the board at the same time. (The next quad-witching day is Dec. 21.)

If you thought the Fed leveled the playing field with that surprise discount rate cut in concert with August expiration, just think what a surprise interest rate cut could do for the markets before the opening bell on the 21st!

So, is there any value to the "sell Rosh Hashanah and buy Yom Kippur" theory? Maybe. But for my money, the tried-and-true "don't fight the Fed" adage is looking like a much better bet!


Jon "Doctor J" Najarian
Editor
ChangeWave Options Trader