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Market Indicator for the Week Ahead – September 19, 2011

Five-Week Expiration Cycle

expiration time

Introduction

October is set to have a five-week expiration cycle. As option traders surely realize, last week was September options expiration. October-dated options will now spend the next five weeks as the front-month series. Most expiration cycles only last four weeks, but we periodically get a longer five-week expiration cycle. But first, let us further examine what an options cycle means.

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Options Expiration Cycles Explained

Option expiration cycles are used for equity, commodities, and currency options.

It is a pattern of months in which option contracts usually expire (usually a nine month period).

Options Expiry Dates

All ”options” have a limited useful lifespan and every option contract is defined by an expiration month. The option expiration date is the date on which an options contract becomes invalid and the right to exercise it no longer exists.

For all stock options listed in the United States, the expiration date falls on the third Friday of the expiration month (except when that Friday is also a holiday, in which case it will be brought forward by one day to Thursday).

There are three common cycles:

JAJO - January, April, July, and October

MJSD - March, June, September, and December

FMAN - February, May, August, and November

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Now let us take a look back to see what these extended expiration cycles typically mean for stocks. However, it is important to first examine individual stock names before checking out typical market returns.

Less Is More

According to the data below, the market is more likely to struggle during five-week cycles as compared to four-week cycles. This is especially clear when looking at the S&P 500 Index (SPX) returns since 2009 (the second table below). Since that time, from expiration to expiration, the index averages a 2.04% return during a four-week cycle. On the other hand, the five-week cycles average a loss of 1.32%. You'll also see the SPX returns since 2006, which confirm the trend toward weaker price action during longer expiration cycles.

expiration 1



Looking at those five-week expiration cycle returns individually, we see that most are positive. The problem is that three out of the four negative cycles had huge losses. During the five-week cycles in February 2009 and May 2010, the SPX lost roughly 9%. The most recent five-week cycle was just this past August – which was quite disastrous; as I'm sure we all remember where we saw the market tumble almost 15% from July expiration to August expiration.

expiration 2



Individual Stocks during the Five-Week Expiration Cycle

It is quite obvious that the SPX has tended to under perform during a five-week cycle in recent history. However, certain individual stocks, listed below, for whatever reason, have tended to outperform during five-week expiration cycles relative to four-week cycles.

In fact, these stocks rarely manage to rise during four-week cycles, and often average a negative return -- but they're most frequently on the upswing during five-week cycles, averaging a positive return over these longer time frames. Notably, the table is dominated by precious metal stocks, oil companies, and utilities. This out-performance is especially impressive, considering the broader market's bearish tendency during five-week cycles. The last column in the table simply shows the difference in average returns for the two cycles.

expiration 3



Finally, here are the stocks that are most bearish during a five-week option cycle as compared to four-week cycles.

expiration 4




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