One of the often-cited seasonal patterns in the stock market is the October effect. This refers to the belief that stocks tend to decline during October. This belief is reinforced by the fact that some major market crashes happened during October in the past. Some notable examples include the Panic of 1907, October 1929 leading to the Great Depression, and Black Monday in 1987.
Option market participants are pricing in this fear as reflected by the jump in option prices from September to October expiries this year. This can be seen in the VIX futures term structure, showing a jump in implied volatility for the October contract. To be sure, the October implied volatility of 20.8 is not in extreme fear territory. For context, 20 is considered the normal level for VIX. However, note that VIX has been suppressed below 15 recently so 20.8 is still a significant departure.
The US Presidential Election takes place on 5 November this year, so the jump can also be attributed to this event as market participants expect volatility to pick up in October as the contest heats up toward polling day. Nevertheless, this kink in the term structure motivated me to investigate the October effect further.
There are two things I wanted to find out. First, how does the S&P 500 monthly return for October compare to the other months? Second, is October the most volatile month in the whole year? For this study, I downloaded the entire history of daily closing prices for the S&P 500 from Yahoo! Finance. The data starts from 30 Dec 1927. Below is what I found out.
Is October the Worst Performing Month?
For this part of the study, I tabulated the monthly returns of the S&P 500 and determined the respective minimum, maximum, and average monthly returns for each calendar month.
October did register one of the worst monthly returns. This should not be a surprise given that the worst market crashes happened in October. However, the worst month actually happened in September, followed by March and May. October delivered good months as well but it was middle of the pack. The ones that delivered the best months were from April to August. On average, October actually delivered positive returns although only marginally. If anything, it should be called the September effect because September lost 1.2% on average.
Therefore, the October effect doesn't seem to hold based on returns alone.
Is October the Most Volatile Month?
For the second part of this study, I calculate the one-month realized volatility (RV) of the S&P 500 using the daily return series. I then compare the minimum, maximum, and average annualized one-month RV for each calendar month.
October is the clear "winner" in the volatility category. Although it only registered the third-highest realized volatility, with the record going to November, any reading above 90 is already of historic proportions. Anything higher is just noise. What is notable is that October's average realized volatility is a head above the rest of the calendar months. This suggests that October is more volatile than other months on average.
In conclusion, the October effect seems to be valid when it comes to volatility, but inconclusive in terms of monthly returns.
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