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Five Stocks for the Year-End Rally

The power and speed of the recent rally -- certainly including today -- is likely the result of money managers, having looked at flat returns for the bulk of the year, chasing prices somewhat indiscriminately higher as they look to bolster year-end performance. There is no reason to expect this run will end at a particular price level or prematurely just because it started earlier than the "traditional" year-end rally. The best stocks to pile into and drive higher are small-caps, which already have momentum in their favor and short-sellers on the run.

Rather than the broad market play of buying into the Russell 2000 or its ETF, the Russell 2000 iShares (IWM), I'm looking to really give myself over to this parabolic move and try to ride the best performers right through New Year's celebration.

I ran a simple screen for stocks with a market capitalization between $500 million and $1 billion that have gained more than 50% for the year and have shown a double-digit percentage increase in the short position. I also set the range of daily minimum volume between 100,000 and 1 million to eliminate some of the names that are just too illiquid for money managers to have a meaningful stake, or those in which it would take an unusual commitment to drive the price higher.

The screen produced over 100 names, which was whittled down to 78 when I added the short interest parameter (which required an additional screen and some manual checking). And because I want to buy calls, rather than the underlying shares, I was able to reduce the list somewhat to a more manageable 37 names by only considering stocks with exchange-traded options.

Using options will not only require less capital outlay and supply more leverage, but will also offer a limited risk equal to the cost of the call. In addition, given that current volatilities are trading at historically low levels, and since the time frame for the January-effect trade is very specific and short, the time erosion shouldn't be too severe as we will look to exit the trade on Jan. 7 or the first Friday of the month.
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