While playing email catch up today I came across an interesting question.  Someone noticed that as the market was nearing the close this past Friday (12/16) someone came in and put on a sizable trade using options on the iShares Russell 2000 Index ETF (IWM).  With IWM at 135.90 there was a seller of 11,800 IWM Mar 17th 110 Puts for 0.48 who then purchased the IWM Mar 17th 92 Puts for 0.09 and a net credit of 0.39.  The payoff at March expiration appears below.

iwm-po

The long 110 strike is about 19% lower than where IWM was when the trade was executed and the 92 price level is down about 32%.  As long as IWM doesn’t lose 19% this trade results in a profit of 0.39 and if IWM goes into a full blown crash and loses 32% the net result could be a loss of 17.61 a spread.

The specific question about this trade was, “Why didn’t the trader behind this trade use RUT options?”  They went on to note that RUT options give you ten times the market exposure related to IWM options which means a comparable trade only needs to use 1,180 RUT options.  That’s a darn good question and it got me to doing some work to see if the same, or a very similar trade, could be executed using RUT Index options.

About the time this trade was executed the Russell 2000 was at 1364.20 which is slightly more than 10 times the level of IWM.  I pulled the quotes on the RUT Mar 17th 1100 Put and RUT Mar 17th 920 Put and determined that the 1100 Put could be sold for 4.50 and the 920 Put could be purchased for 0.70 at the time of the previous trade.  The result is that a comparable put spread could be initiated for 3.80 a spread.

rut-iwm-po

The 1100 strike price is just over 19% lower than where RUT was when the trade was initiated so a similar outlook as the IWM trade would work here as well.  Finally, and sort of the kicker here, is that the same dollar risk / reward could be achieved by selling 1180 RUT Mar 17th 1100 Puts and buying 1180 Mar 17th 920 Puts or trading a much lower number of contracts.