This week’s sell-off in the U.S. stock market contributed to making this December’s price performance one of the worse in many years.  The Russell 2000 Index (RUT), the benchmark for the U.S. small-cap performance, outperformed other U.S. equity indexes on the way up in early 2018 and has underperformed during the tail end of the year.

The RUT is down more than 10 percent in the month of December. Several factors contributed to the index decline, including rising U.S. interest rates and trade friction, which led investors to reduce their equity exposures across most segments in the December 1–17 period.  (See below chart).

Investor concerns have also been stoked by recent comments from some of the industry’s most respected names. For example, hedge fund manager Paul Tudor Jones told CNBC last month, “We’re in a global debt bubble and headed for some scary moments.” And DoubleLine Capital CEO Jeffrey Gundlach suggested Monday that “the S&P 500 is headed to new lows.”  It’s no wonder the Cboe VIX Index, is on the rise. The VIX Index, which measures expected 30-day volatility based on SPX options, rose by more than 35 percent in December through the 17th, as seen in the chart below.


Russell 2000 Index Bear Market

After the Russell 2000 made new all-time highs (1742.09) on August 31, the index sold off by 20.6 percent, leading the charge into bear market territory.  This recent move warrants a closer look at the level of volatility in RUT as measured by Cboe’s Russell 2000 Volatility Index (RVX) and the expectation for continued volatility. The December 17 RVX Index close of 28.04 was significantly higher than the average RVX close of 18.50 over the last five years.  In fact, RVX closed above 30.00 on six occasions over this time frame.  Contrarians might point out the fact that U.S. equity indexes found support shortly after each recent RVX close above 30 (Aug. ’15, Feb. ’16, and Feb. ’18), as highlighted below.

Sources: Bloomberg & Cboe Global Markets

RUT Vertical Put Spread

Attempting to express a view on the market during periods of market turbulence is challenging.  An options-based strategy like a Vertical Spread allow an investor to define a risk and potential return relationship for a given period of time.  For example, a bullish view can be expressed by purchasing an out-of-the-money call and selling a higher strike call to finance the purchase.  To illustrate, we’ll look at the following hypothetical position:

rrpost1

Buy

1

RUT

Dec 31 '18

1450

Call

5.75

Sell

1

RUT

Dec 31 '18

1470

Call

3.00

Net Debit

1.13

 

This RUT Dec 31 ’18 1450/1470 Call spread has a maximum potential risk of $113 if held until expiration and RUT settled below 1450.  In the event RUT reversed course and rallied 6 percent into the end of this year, the maximum value on the spread would be $2,000 minus the premium paid ($113) which works out to $1,887, not including transaction costs.  Prior to December 7, the last time RUT closed below 1470 was on September 26, 2017.

For additional information on RUT and RVX please visit the following webpages:

www.cboe.com/RUT

www.cboe.com/RVX