The first thing that popped in my mind when I created the first chart in this blog was the story “The Little Engine that Could”. This was a pre-Thomas the Tank Engine story of a little locomotive that achieves a great feat while telling himself “I think I can” repeatedly. My mental analogy relates to the Russell 2000 (RUT) line below which pushed higher by over 3% last week closing the 2015 YTD gap with the Russell 1000 and also moved very close to positive territory for the year.
Despite the strong performance of small cap stocks, the risk premium difference between the Russell 2000 Volatility Index (RVX) and CBOE Volatility Index (VIX) remained at relatively high levels. Both RVX and VIX were lower on the week as equities moved higher, they just moved in line with each other.
On Friday as the Russell 2000 rose about 0.75% in response to the employment number the out of the money credit spread players came into the market. A couple of trades of note focused on the November 20th expiration series.
First, just after lunch time with RUT up slightly on the day around 1193 a trader came in and sold the RUT Nov 20th 1250 Calls for 0.75 and purchased RUT Nov 20th 1255 Calls for 0.55 and a net credit of 0.15. The dollar risk is big if RUT rallies 5.2%, but as long as RUT does not move up by more than 4.8% over the next two weeks this trade will yield a profit equal to the 0.15 credit minus commissions.
The second trade was executed with just a few minutes left in the trading day and was at the opposite end of the spectrum of strike prices. With RUT at 1199 there was a seller of the RUT Nov 20th 1095 Puts at 0.71 who then purchased RUT Nov 20th 1045 Puts for 0.31 and a 0.40 credit. An 8.7% drop over two weeks gets us to break even and a 12.8% drop would result in a loss of 49.60 per contract. I sit her struggling with words the describe how bad I’m sure the entity behind that trade would feel if the little RUT engine runs out of steam and falls backwards down the hill that sharply.