Sell the Santa Claus Rally

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This is my favorite time of year.

As a kid, it was always exciting to race downstairs to find a Christmas tree filled with gifts that Santa had dropped off the night before.

Now, as a parent, I get to pass that moment of joy and excitement along to my kids — although I’m convinced it’s more exciting for me than for my kids.

Nonetheless, it tends to be a shining moment every year when Santa shows up bringing the perfect gifts.

It also happens to be a shining moment for the stock market after Santa visits town. But this year may be a bit different as the joy from Santa’s gift loses its luster a lot faster than you might be expecting…

Since 1969, 77% of the days that cover the holiday period from Christmas through two days after the new year, the market has rallied. This is often referred to as the Santa Claus Rally.

But I don’t want you to try to position your portfolio to benefit from this stock-market phenomenon by raking in more gains. Instead, I’d rather use it as a time to take profits, lower your exposure and add some protection. Let me explain…

The Santa Claus Rally

The rationale behind the rally is still uncertain.

It could be due to light trading volume during the holiday period, as many traders and investors go on vacation. Or it could be fund managers attempting to spruce up portfolios at the end of the year, a little so-called window dressing to improve the appearance of a portfolio or fund performance. Or it could simply be Santa spreading the same positive vibes he spreads in homes on Wall Street.

But you can’t argue with its 77% accuracy rate. That’s why I don’t really care that I can’t pinpoint the root cause of it; I still know the odds of it happening yet again are greater than it not happening.

With that said, I do believe this time is different.

Not in the sense we may not get a rally at all, but what to do with the rally is how this year differs from most.

Protect Your Portfolio Now

Over the past several years, we’ve enjoyed positive results by the end of the year, usually in the form of double-digit percentage gains. However, for 2016, I see a different scenario playing out, and the recent Federal Reserve rate hike pushes me even more in this direction.

I see the S&P 500 falling by a significant amount or, at best, finishing 2016 flat. I’ll explain more about why in an upcoming Sovereign Investor Daily, but for today, you should use this make-believe rally to take some cash off the table and purchase some protection.

With regards to taking cash off the table, start with some of the positions you are concerned about, the ones that keep you up at night. Whether that means you are securing profits or taking a loss, it doesn’t matter. Start with those to lighten your exposure to this market.

Then add some protection. Take some of that excess capital and protect the remainder of your portfolio that is still invested in the market. An easy way to do this is to grab a put option on the SPDR S&P 500 ETF (NYSEArca: SPY). This exchange-traded fund (ETF) tracks the performance of the S&P 500. By purchasing a put option, you benefit if the broad market, the S&P 500 that is, falls over the coming year — as I expect will happen.

Purchase a SPY January 2017 $200 put option at the market.

This will protect your portfolio over the next year from volatility as well as a downdraft in the market.

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Chad Shoop
Editor, Pure Income