MW 'January effect' arrives early as small caps are roaring past the Dow and S&P 500
By Lawrence G. McMillan
Seasonality favors U.S. stocks through year-end - especially the Russell 2000
Small-cap stocks are making themselves heard.
This is the most wonderfully bullish time of the year for stocks. First, there is the post-Thanksgiving bullishness. This year, that didn't amount to much, but it's typically followed by an outperformance by small-cap stocks in the middle of December. The bullish seasonal pattern concludes with the "Santa Claus rally" at the end of the year.
We are now entering the second phase. This used to be called the "January effect." It got its name from the fact that small-cap stocks that had been dumped in December rebounded in January. As with many Wall Street patterns, the timeline accelerated as traders attempted to jump in ahead of the crowd. As a result, the "effect" moved into December a number of years ago and remains there today.
We recommend trading this with Russell 2000 ETF IWM options. IWM has been outperforming the S&P 500 SPX in recent weeks and made a new all-time high this week. This comes after years of underperformance.
We will choose an expiration date in January in order to encompass the upcoming third part of the seasonal pattern:
Buy 2 IWM (Jan. 9th) at-the-money calls
Roll the calls up if they become 6 points in-the-money. There is no downside stop, so the entire initial debit is at risk.
S&P 500 breaks out - for now
The S&P 500 climbing over 6,900 on Thursday is highly positive and should generate some significant upside momentum if it lasts. Prior to this, the U.S. benchmark stock index had traded within a narrow 100-point range for more than a week. The index now sits at the top of the much wider 6,500 to 6,900 trading range that has encompassed trading since October (bounded by the red horizontal lines shown in the accompanying SPX chart).
Realized volatility is contracting a bit with SPX being in this trading range, and the "modified Bollinger bands" are beginning to retreat toward the center, but so far this has not produced a new McMillan volatility band (MVB) signal.
Equity-only put-call ratios have generally been climbing since mid-October, but now they are beginning to curl over. The weighted ratio has officially curled over to a new buy signal. By "officially," I mean that the computer programs that we use to analyze these charts have agreed that such a buy signal is now in effect. It is marked with a green "B" on the accompanying chart. However, the standard ratio, while appearing to be similarly rolling over, has not yet been upgraded to a buy signal.
Regardless of the analytics, a 10-day peak is automatically a buy signal, and that would occur early next week. This chart is marked with a green "B?" to signify that there is still a bit of lingering doubt about the standard ratio's buy signal.
Market breadth has struggled to maintain the buy signals that were generated a week ago, but so far it has been able to do just that. The "stocks only" breadth oscillator remains on a buy signal and is even in modestly overbought territory. The NYSE-based breadth oscillator has toyed with a sell signal over the past week, but has not been able to sustain one.
Meanwhile, cumulative volume breadth (CVB) is improving nicely. The NYSE-based CVB has twice made a new all-time high in the past week. The "stocks only" CVB is only a tiny distance away from making a new all-time high of its own. When these CVB indicators make new all-time highs, SPX normally follows along. So, this is a strong indicator in favor of the upside breakout occurring in SPX.
New highs on the NYSE have continued to outnumber new lows on a daily basis. Thus, this indicator remains bullish for stocks. It would only falter if new lows were to outnumber new highs for two consecutive days.
The implied volatility indicators - based on VIX VIXand its various trading vehicles - are quite bullish at this time. When the 20-day moving average of VIX crossed below the 200-day moving average this past week, that created a new trend of VIX buy signal (circled area on the accompanying VIX chart). That will remain in effect unless VIX closes above its 200-day moving average for two consecutive days. Meanwhile, the "spike peak" buy signal that was generated back on Nov. 21 remains in effect (the green "B" on the VIX chart). Unless stopped out, the "spike peak" buy signal has another two weeks to run.
The construct of volatility derivatives remains bullish for stocks, too. The term structures are sloping strongly upwards, and the VIX futures are trading at a premium to VIX.
One other factor that is important is seasonality. This is typically a seasonally bullish time of the year, lasting through the first two trading days of the new year.
In summary, most of the indicators are bullish, but the confirmation of that needs to come from a breakout by SPX above 6,900. If that breakout doesn't happen, then once again SPX will be defying the internal indicators of the market. It happens, although infrequently. In any case, we will take positions when indicators generate new signals, and we will continue to roll deeply in-the-money options.
New recommendation: Potential breakout
This recommendation is repeated from last week: If SPX breaks out to new all-time highs, we want to add to our bullish positions.
If SPX closes above 6,900 for two consecutive days, then buy 1 SPY SPY (Jan. 16) at-the-money call and sell 1 SPY (Jan. 16) call with a striking price 20 points higher.
If this recommendation is established, stop yourself out if SPX closes back below 6,800.
New recommendation: Trend of VIX buy signal
There is a new trend of VIX buy signal in force. It occurred when both VIX and its 20-day moving average crossed below the 200-day moving average. The signal was effective on Dec. 4.
Buy 1 SPY (Jan. 9) at-the-money call and sell 1 SPY (Jan. 9) call with a striking price 15 points higher.
This position would be stopped out if VIX were to close above its 200-day moving average for two consecutive days.
Follow-up actions
All stops are mental closing stops unless otherwise noted.
We are using a standard rolling procedure for our SPY spreads: In any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll up in the case of a call bull spread or roll down in the case of a bear put spread. Stay in the same expiration and keep the distance between the strikes the same unless otherwise instructed.
Also, for outright long options, roll if they become 8 points in-the-money.
Long 1 TSEM $(TSEM)$ (Dec. 19) 115 call and short 1 TSEM (Dec. 19) 130 call: Continue to hold without a stop for now. Roll up at 130.
Long 2 expiring CME $(CME)$ (Dec. 12) 285 calls: The put-call ratio has rolled over to a sell signal, so do not replace these expiring calls.
Long 1 SPY (Dec. 26) 679 call and short 1 SPY (Dec. 26) 699 call: This is the "spike peak" buy signal position. The original spread was rolled up when SPY traded at 679. It will be held for 22 trading days. Change the stop: Stop this position out if VIX rises at least 3.00 points over any three-day or shorter time horizon, using closing prices.
Long 2 PLD $(PLD)$ (Dec. 19) 125 puts: Sell these puts now since the put-call ratio has rolled over to a buy signal.
Long 2 expiring SPY (Dec. 12) 682 calls and short 2 SPY (Dec. 12) 697 calls: This is our post-Thanksgiving seasonal trade. It is now time to roll to the Russell 2000 ETF options. Sell this spread and buy 2 IWM (Jan. 9) at-the-money calls.
Long 3 SLV SLV (Jan. 16) 48 calls: We will hold these calls as long as the weighted put-call ratio buy signal remains intact.
Long 1 GLD GLD (Jan. 16) 390 call and short 1 GLD (Jan. 16) 415 call: We will continue to hold as long as the put-call ratio remains on a buy signal.
All stops are mental closing stops unless otherwise noted.
Send questions to: lmcmillan@optionstrategist.com.
Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager and is the author of "Options as a Strategic Investment." www.optionstrategist.com
(c)McMillan Analysis Corporation is registered with the SEC as an investment advisor and with the CFTC as a commodity trading advisor. The information in this newsletter has been carefully compiled from sources believed to be reliable, but accuracy and completeness are not guaranteed. The officers or directors of McMillan Analysis Corporation, or accounts managed by such persons may have positions in the securities recommended in the advisory.
-Lawrence G. McMillan
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December 13, 2025 14:43 ET (19:43 GMT)
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