Sell in May and Go Away? Sell what?!

Many investors have heard the phrase “Sell in May and go away”. But this is an often-misconstrued trading idiom. Specifically, traders need to understand what to sell. If this long-standing trading wisdom is misunderstood (and implemented the wrong way), it can be detrimental and make for lousy trading results this summer.

Overly-simplistic traders (who are not options savvy) consider this phrase only from an equities standpoint. That is, sell stocks in May and get back in the market after the summer. The rationale for this logic is that the summer months typically see lower volumes and, therefore, lower liquidity. The idea is stay out of the game because stock trading is less optimal during the summer months.

Though there is some logic to this wisdom, there is a more important historically observed market pattern prevalent during the summer that relates to option trading. Because there is historically less trading in the summer, volatility in the equity market falters as well. But for option traders, lower volatility can be an opportunity.

Income trades are a family of option trades that profit in low-volatility environments. Income trades are also referred to as “option-selling strategies” because they result in a net selling of option premium—that is, usually they result in a credit to the traders account and hey have the quintessential characteristic of a short option position (i.e., positive theta).

These strategies include: credit spreads, iron condors, butterflies, time spreads and more. When traders expect the market to be stable, it is a prime time to put these strategies to use.

Sell in “May and go away” relates to the historically successful opportunities for option traders who implement these option-selling strategies going into the summer months. Selling in May allows them to cash in on the low volatility expected between May and September. Non-option traders who sell their equity investments and stay out of the market for the summer months miss out on potential opportunities that clever option traders may be able to exploit.

Dan Passarelli

dan@markettaker.com