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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