Cboe Global Markets

A New Year for the Russell 2000

January 6, 2022

In partnership with Cboe™ and FTSE Russell, Russell Rhoads, Head of Research and Consulting at EQDerivatives, is publishing a series of articles about the Russell 2000 Index. In this article, Rhoads analyzes three trades from December.

Historically, the best month of the year for the Russell 2000 is December, and including its positive performance last month, RUT has been higher 27 of 33 annual observations or 81.82% of the time. January, on the other hand, is one of the weaker months as far as win percentage for RUT with the small cap benchmark up only 51.25% of the time. A summary of monthly win percentage for the Russell 2000 appears below.

Data Sources: Cboe Global Markets & EQDerivatives Calculations

The Russell 2000 has a distinct seasonality surrounding performance by month. January is in the middle of a period of positive performance, but on average January performance has been slightly positive at 0.48%. The chart below shows the average performance by month for the Russell 2000 from 1989 to 2021.

Data Sources: Cboe Global Markets & EQDerivatives Calculations

A Look Back at Three Bearish Trades

Knowing the historical performance for the Russell 2000, I decided to dig into the tape on Dec. 31 and see how traders were using RUT options expiring on Jan. 31, 2022. The market sentiment in RUT options has a bearish overtone given the Put/Call ratio around 1.85 during December. Given this negative outlook, there are 3 bearish trades to highlight.

Put Butterfly

The first trade is bearish and occurred when RUT was at 2251.55. Specifically, a trader sold 1 RUT Jan 31 2160 put for 23.17, bought 2 RUT Jan 31 2210 puts for 35.33 each and finished out a put butterfly by purchasing 1 RUT Jan 31 2260 put for 54.19. These trades resulted in a cost of 6.70 per butterfly and a payoff at the end of January, appearing in the diagram below.

Break-even for this butterfly is slightly higher than where the Russell 2000 was trading when the trade was implemented. To the downside, there is a 3.77% buffer to break-even. I checked historical numbers and a 3.77% or greater drop for RUT has occurred just over 15% of Januarys going back to 1989, so there is some risk on the downside for this trade, however, it is capped at a loss of 6.70, or the cost of the spread.

Bear Call Spread

A second trade is also bearish, but with a very wide berth if RUT moves higher in January. When RUT was at 2252.70 a trader sold the RUT Jan 31 2420 call for 3.95 and purchased the RUT Jan 31t 2430 call for 3.35 taking in a credit of 0.60. If held to expiration, this trade risks 9.40 to make 0.60, which does not appear to be an attractive risk/reward scenario. However, the payoff diagram below shows what needs to happen for this trade to result in a loss.

Break-even for this trade requires a 7.46% gain for the Russell 2000 in January. This is not outside the historical range, as RUT gained 10.60% in January 2019, but circumstances were a bit different since RUT was down 12.84% the month before (December 2018), so the January performance was a rebound from the worst December on record.

Iron Condor

Finally, a neutral trade that has a very wide range of profitability. With RUT at 2251.86 a trader put on an iron condor expiring on the last day of the month. The trade structure purchased the RUT Jan 31 2090 put for 13.26 and sold the Jan 31 2100 put for 14.28. To the upside, the RUT Jan 31 2370 call was sold for 9.48 and the RUT Jan 31 2380 call was purchased for 8.00. This RUT Jan 31 2090 / 2100 / 2370 / 2380 iron condor took in a credit of 2.50 with a potential loss of 7.50.

Break-even on the downside for this trade is a loss of 6.85% while the upside risk is a gain for RUT of 5.36%. This over-12% range is wide for a month that on average gains less than half a percent and has a slightly better than 50% history of closing higher.

All three trades that hit the tape on Friday, Dec. 31 using Jan 31 options make sense in the current market environment along with the historical performance of the Russell 2000 in January. As always, time will tell regarding profits and losses, but the logic for all three is solid.

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Contact the author at [email protected].


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