Last week small cap stocks took it on the chin with the Russell 2000 (RUT) dropping about 2.5% while the Russell 1000 (RUI) actually gained about 0.7%. The divergence between the two widened to over 5% with RUI in the lead for 2017.
VIX gained a bit last week which narrowed the gap between the CBOE Russell 2000 Volatility Index (RVX) and VIX to around 40%. This is low by 2017 standards, but still pretty high relative to the long-term history of these two indexes.
The last very sizable trade in the RUT pit last week was an attempt to thread the needle with respect to the coming week’s RUT settlement. As a reminder, this coming Friday is an old school standard third Friday expiration which means RUT options settle on the open through the AM settlement process.
With RUT at 1365.26 a trader purchased 100 RUT Mar 17th 1330 Puts at 2.15, sold 200 RUT Mar 17th 1320 Puts at 1.37, and bought 100 RUT Mar 17th 1300 Puts at 0.75. This is what is commonly referred to as a broken wing butterfly and each one cost this trader 0.16. The payout if held through Friday’s AM settlement looks like the diagram below.
I highlighted several significant points on the diagram. Break-even on the downside is 2.5% lower than Friday’s RUT close. If RUT is 3.3% lower, landing right at 1320 the result is a maximum profit of 9.84. The second break-even level is down 4.0% and the worst-case scenario for this trade is a drop of about 4.8% or more placing RUT under 1300 and this trade losing 10.16 per spread.