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ETFs and Stocks to Play a Year-End Rally

After a horrible September, the markets delivered a glorious October, only to have the goblins ruin November, which turned out to be a big turkey.

So will we see a Santa Claus Rally at the end of the year? And if so, what stocks should we be buying here? Let's look at some of the pertinent statistics that may help answer our questions.

(I use my own proprietary statistics that quantify and analyze the Standard & Poor's 500 from 1950 through 2010.) Historically, December is the best month for the S&P 500, with an average gain of 1.65 percent. The second best-performing month, on average, is November.

December is also the least historically volatile month, with a standard deviation of returns of 3.17 percent. The next least-volatile month is March.

Since 1950 (61 years), the S&P 500 has declined on 21 occasions, not including this year, in November. In only three of those years did a down December follow a down November: in 1969, when the S&P 500 declined by 1.87 percent; in 1974, down 2.02 percent; and in 2007, down 0.86 percent.

The average return in December following a down November is 2.61 percent. Excluding those three down Decembers, the average gain is 2.8 percent.

In years before a presidential election, such as 2011, December has gained on average 3.34 percent, more than double its usual annual return. Only 2007 was a down year for November and December in the year before the presidential election.

Have there been other years in which September was down, October was up and November was down for the S&P 500? Certainly.

That occurred seven times, followed by both up and down Decembers: in 1956, when the S&P 500 rose 3.52 percent in December; in 1963, up 2.44 percent in December; in 1969, down 1.87 percent in December; in 1974, down 2.02 percent; in 1991, up 11.16 percent; in 1993, up 1.01 percent; and in 1994, up 1.23 percent in December.

That average December return was a 1.78 percent gain. So yes, there is most definitely some statistical evidence that a rally could occur this December.

With that in mind, here are several stocks and strategies for a 2011 Santa Claus Rally.

ETFs:

I would be inclined to point you in the direction of the SPDR S&P 500 , an exchange-traded fund that tracks the S&P 500 on a 1-to-10 basis (the SPY is approximately one-tenth of the SPX). This will allow you to participate in the expected positive performance in the index.

Furthermore, the SPY is expected to go ex-dividend in mid-September for approximately 62 cents, which is about 0.5 percent.

For those of you who are a little more daring and less risk-averse, you may want to look at the leveraged version of the SPDRs, the ProShares Ultra S&P 500 . The ProShares Ultra S&P 500 provides a two-times return of the S&P 500.

However, be forewarned that the double gearing is recalculated every day and is not intended to be held for long period of time. Furthermore, the volatility on these leveraged exchange-traded funds is far greater than the non-leveraged variety.

Options Plays:

Clearly, implied volatility expanded greatly during November. Therefore, if you are hoping for a short-term rally, then I would caution against buying short-term volatility. That means you should be selling options rather than buying them. This brings added risk as well.

Thus, I would suggest selling option spreads to protect your trade from the possibility that December does not pan out as expected.

In order to do so, we would have to sell putspreads.

If our expected return for December is somewhere in the range of 1.65 percent to 3.3 percent, then I would suggest selling a put spread with the higher strike that is about three or four points higher than the lower strike. I would use the options on the SPDRs to achieve this objective.

Furthermore, I would use an expiration day to coincide with the end of the fourth quarter.

Stocks:

The analyst community believes the holiday shopping season will be up 2 percent year over year. I think we could have a more robust season.

Already, Black Friday spending rose 7 percent over 2010, and Cyber Monday sales rose 22 percent.

However, as always, this will be a bifurcated market. I would suggest focusing in on the retailers and consumer-based companies that have something to put in the sleigh for the holidays.

Here are a few that should work for that Santa Claus rally.

- Retail: Amazon.com.

Amazon.com is hoping that its new Kindle Fire will generate sales. The Kindle Fire could be the right product for people who do not want to pay up, at least initially, for the Apple iPad.

In the long run, the iPad will do to the Kindle what the iPhone did to the BlackBerry.

But in the short run — and here we are talking about a short-term strategy — the Kindle will sell and likely create a halo effect of add-on sales for Amazon.com. The stock was off about 10 percent in November, is up over 2 percent so far in December and could gain nicely on a market snap back and strong sales.

- Travel: Hertz.

Travel reportedly increased for this year's Thanksgiving holiday over last year's, and I anticipate this trend to continue well through the end-of-the-year holidays. A big beneficiary will be airlines, but that is an untradeable and uninvestible sector.

There is no way to play the rails from the perspective of the public traveler. So I want to reach out to the auto rental companies.

My first thought was Zipcar , an initial public offering from earlier this year, but that company is still operating at a loss, and it seems that the IPO class of 2011 is not performing well.

Instead, I headed to the checkout counter at Hertz . Hertz will benefit from the rush to travel out of town. Earnings are expected to grow 76 percent in 2011 and 41 percent in 2012.

The stock sells at a very cheap 8 times forward earnings, which makes this company both an interesting investment and themed trade.

- Short Squeeze: Quidel.

If we expect a Santa Claus Rally, then the short-selling Grinches will be the first to spring to action and will begin to cover shorts. Many short sellershave earned some nice gains betting against high-beta and high-price-to-earnings stocks in the last month.

Just witness what has happened to Salesforce.com , Netflix , Green Mountain Coffee and Baidu .

But some heavily shorted stocks have not been so kind to the short-sellers over the last few months. One of them is Quidel , a manufacturer of medical testing products and devices. This is a growth area within the health-care sector.

Quidel's stock has increased in value since the summer's market lows. Short interest is approximately 20 percent of the float and represents around 34 days of trading volume; a larger short squeeze could be in the works if the market rallies.

Additional News: Is Amazon.com Readying a Kindle Smartphone?

Additional Views: Portfolio Manager Dion Likes This Tech ETF for the Holiday Season

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