Large capitalization (stocks with large market values like those in the DJIA) stocks often rally before the end of the year. At the beginning of the new year, small capitalization stocks tend to rally in what has become known as the January effect. Small cap stocks also frequently lag behind large cap stocks during a market rise and sometimes never catch up to the large cap stocks. You can take advantage of these seasonal return patterns of different classes of stocks by trading spreads between CBOT. DJIASM futures and futures on a small capitalization index.

Scenario: Your analysis of the market has increased your confidence in the regular occurrence of an early winter rally concentrated in large capitalization stocks. You currently own $242,000 DJIASM stocks and $158,000 small capitalization stocks and want to reinvest this $158,000 in DJIASM stocks to fully exploit the rally.

Strategy: To gain the greatest advantage of the anticipated rally in large cap stocks, buy CBOT. DJIASM futures and sell small cap futures contracts.

Inputs: In September, the DJIASM is 7900 and the price of CBOT. DJIASM December futures is 8018. The value of the stock index most closely correlated to your holdings of small cap stocks is 395, and the price of the futures contract on this index is 400.90. The multiplier of this contract is $100. The numbers of contracts to buy and sell are:
Buy CBOT. DJIASM futures $158,000 / ($10 x 7900) = 2
Sell small cap futures $158,000 / ($100 x 395) = 4

Results: By December, the DJIASM is 8295 and the small cap index is 402.90. The total value of your positions in large and small cap stocks and stock index futures is:

Value of Portfolio with No Market Action Taken
LARGE CAP STOCKS $242,000 x 1.05 = $254,100
SMALL CAP STOCKS + $158,000 x 1.02 = $161,160
$415,260

Value of Futures Positions
LONG CBOT. DJIASM FUTURES 2 x $10 x (8295 - 8018) $5,540
SHORT SMALL CAP FUTURES + 4 x $100 x (400.90 - 402.90) $(800)
$420,000

Value of Portfolio with Cash Market Transactions
LARGE CAP STOCKS $400,000 x 1.05 = $420,000
SMALL CAP STOCKS + $0
$420,000

Comments: Your asset reallocation by using the futures market produces a portfolio with the same return as a $400,000 investment in the DJIASM. The short position in small cap stock index futures converts the $158,000 investment in small cap stocks to a $158,000 money market investment. The long position in CBOT. DJIASM futures converts the $158,000 money market investment to a $158,000 investment in the DJIASM portfolio. The value of your investments increases by $4,740, in spite of the fact that the short futures position in the small cap contract had a loss. Note that if the January effect kicks in, you can easily switch back to small cap stocks. Once the December futures contracts expire, your portfolio returns to a mix of DJIASM and small cap stocks. If you wish to emphasize the weight of small cap stocks further, you can sell CBOT. DJIASM futures and buy small cap index futures.