Stocks were lower last week, but the small cap sector seemed to hold up a little better than large caps. The Russell 2000 (RUT) was down 0.45% while the Russell 1000 (RUI) was under a bit more pressure dropping 0.88%. RUT had lost the 2015 performance lead to the large cap focused RUI a few weeks ago, but took the lead back in late May. This performance margin widened last week and RUT is now up 3.47% for the year with the RUI up 2.82%. It is a lead, but definitely a slim margin which can change pretty quickly.

RUT - RUI Performance

The CBOE Russell 2000 Volatility Index (RVX) was higher by about 8.5%, which is to be expected with RUT under a little pressure. However, the gain in RVX was less than the gain in VIX which rose over 14%. The chart below shows the premium of RVX relative to VIX on a daily basis for 2014. The lower the line, the lower the market perception for relative risk perception regarding owning small cap versus large cap stocks. The premium finished the week just below 20% at 19.65% which is also the average for 2015.


Volatility indexes can signal complacency and may also signal too much fear. This may hold true for the relative volatility index levels. As Warren Buffett says, “Be fearful when others are greedy and greedy when others are fearful.” I am well aware that I’m about to dive into a little Monday morning quarterbacking, but I think there are always lessons in looking at what would have worked in the past. The peak on this chart this year is the first day of May when RVX closed at 18.51 and VIX was at 12.70. On May 1st the Russell 2000 closed at 1228.10 and the Russell 1000 finished the day at 1176.23. As of Friday the RUT is up about 1.5% and the Russell 1000 is basically unchanged since the beginning of last month. Looking at small cap versus large cap performance based on the ratio of RVX to VIX goes on the constantly expanding list of things to do.

This week’s RUT trade is more of a lesson in synthetic positions than a unique strategy. Friday afternoon a trader came in and purchased 2000 RUT Jun 19th 1245 Puts for 16.50 and sold 2000 RUT Jun 19th 1245 Calls at 18.00 for a credit of 18.00 which results in a net credit of 1.50 for the spread. Astute option traders will recognize this as a synthetic The payout diagram for this trade is a straight line with the break-even level of 1646.50 so I’m not going to bother with a picture. Instead I went old school with a table –


RUT options are cash settled, so barring RUT June 19th settlement coming in at 1245, there will be a cash transfer involved in settlement. Above 1245 and the holder of this position would have to pay the in the money amount, while below 1245 they will receive funds. Of course the 1.50 per contract they received when the trade was initiated is theirs to keep. The result of all of this is being short RUT with an effect (pre commission) price of 1246.50.