One of my favorite books when I was a wee lad was “The Little Engine That Could”. When I see the Russell 2000 (RUT) coming very close to going from red to green on the year that story pops in my mind as I personify RUT saying, “I think I can” with the small cap benchmark approaching unchanged on the year. Last week RUT was up by 3% which places the index just 44 basis points in the red for 2016. Pretty impressive for an index that was down as much as 16% on the year. Large cap stocks had a good week as well, but the Russell 1000 (RUI) lagged the Russell 2000 by about 1.3% rising nearly 1.7%. It turns out 1.7% is also pretty close to where RUI is on the year. Since I mentioned the monster rebound in RUT I should note that at the worst point in 2016 RUI was down 11%. That kind of makes the run in RUT look a bit more impressive.
So despite what I say above about the impressive run in RUT compared to RUI, the CBOE Russell 2000 Volatility Index (RVX) move up to relative highs to the large cap focused VIX last week. On average RVX has been at about a 20% premium to VIX in 2016, but finished the week at nearly a 30% premium. The market is still nervous for small cap stocks and it shows in the chart below.
I’m going back to Monday for my RUT trade of the week. As the week began and RUT was around 1103 we had one of those out of the money put spread sellers come into the market. They used the standard AM settled May 20th RUT options to initiate a trade that works out even if RUT revisits 2016 lows. Specifically, they sold the RUT May 20th 920 Puts for 1.43 and purchased the RUT May 20th 900 Puts for 1.03 and a net credit of 0.35. There’s a risk of 19.65, but a lot has to go wrong for this result. The break-even level was 16.6% lower than where the market was at the time of the trade, it is also more than 20 points below the 2016 low for RUT. By name this is a bullish spread, but even a bearish market for the next few weeks will not result in a negative outcome for this trade.