Every weekend I write a brief blog discussing the performance of the Russell 2000, how the CBOE Russell 2000 Volatility Index is reacting to market conditions, and pick out a RUT trade or other piece of market information that looks interesting (at least to me). Last week I noted a bear call spread using Russell 2000 Index Options that sold a deep in the money call and purchased a slightly out of the money call, both of which expired this week. The specific trade involved selling the RUT May 13th 1050 Call for 67.00 and purchasing the RUT May 13th 1125 Call for 5.50 and a next credit of 61.50. The payoff for this trade turned out to be 9.82 based on the closing level for the Russell 2000 on May 13th (1101.68). The full blog from last week describing the details of the trade may be found at the link below –
I also noted that the ‘cost’ of this trade was equal to the maximum potential loss of $1350 per contract. This led me to take a look at shorting a Russell 2000 Mini Futures contract on the closing price Friday, which was 1113.90. The margin requirement for being short a futures contract was $5940, according to the ICE Futures website. At the end of last week’s blog I said I would track the daily profit at loss of the bear call spread and a short futures position. The table and chart below are the result of my side by side paper trading.
Although the futures short would have beaten the option trade, there are some reasons that the option trade may have been the better choice. At least it may have been the less gut wrenching trade. On Monday both trades were down slightly as the Russell 2000 moved up a bit. Then on Tuesday, things got a bit hairy for both trades. The Russell 2000 was up over 10 points on the day and this placed both trades significantly in the loss column for the week. However, note the futures position was four points lower than the option trade based on Tuesday's closing prices. Remember the option position had a maximum potential loss of 13.50, regardless of how much the Russell 2000 move up, so holding tight with the call spread may have been an easier prospect than maintaining a short position in the futures contracts.
As we all know, the outlook for stocks turned negative from Tuesday’s close to Friday’s close. This resulted in a paper profit for a short futures position of 13.40 while based on cash settlement for the RUT options, the profit would have been equal to 9.82. In the end shorting futures was the better trade, but again, the higher margin requirement and potential for substantial losses might make a trader consider an option spread as an alternative to a directional futures position.