The 4.6% gain for the Russell 2000 (RUT) was the biggest one week gain since late October 2014 when (I think) the market was rebounding from an ebola scare. Large cap stocks participated in the rally with the Russell 1000 (RUI) rising 3.26%, but this lagged the rebound in small cap stocks. Despite the ‘win’ for RUT, the Russell 2000 still lags the Russell 1000 by over 1% for 2015 (-3.27 vs. -2.00%).
If this past week were homecoming at Volatility High School the dance theme would be “A Return to Normal”. With the rebound in stocks the macro risk that is associated with VIX diminished when compared to the Russell 2000 Volatility Index (RVX). The average RVX / VIX premium this year is around 19% and we finished the week at 17%, hence the reference to ‘normal’.
Around the open on Friday one of the many out of the money credit spread traders came into the market. The Russell 2000 was around 1166 and the trader sold RUT Nov 20th 990 Puts at 2.09 and bought Nov 20th 980 Puts for 1.77 and a net credit of 0.32. As long as RUT doesn’t give up a tad more than 15% over the next six weeks this trade will end up with a profit equal to the 0.32 credit. The fear for this trader would be the market at 980 or lower at expiration.
A little later in the day there was a bear put spread that kind of replicates the profit or loss that may be experienced by direct short exposure to RUT for the coming week. That is to a certain point. The trader bought RUT Oct 16th 1180 Puts for 20.00 and sold RUT Oct 16th 1140 Puts for 4.30 and a net cost of 15.70. The break-even for this trade is 1164.30 which is within pennies of where RUT was trading when the trade was initiated. This trader will profit up to 24.30 points if RUT moves down to 1140 into RUT AM settlement on Friday next week. The bad scenario would involve RUT at 1180 or higher and a loss equal to the 15.70 cost of the spread.