Going through the block index option trades from yesterday, something caught my eye and it wasn’t bullish. Someone came in to the market about 10:30 Chicago time yesterday and bought 2,200 puts on the Russell 2000 Index (RUT). The specific trade was buying 2,200 RUT Oct 1010 Puts @ 9.50 for a total cost of just over $2 million. At the time RUT was being quoted around 1140.00. If held to expiration the payoff diagram below shows the outcome for this trade –
Taking a look at expiration on October 18, 2014, if RUT is below 1000.50 then this trade will turn out to be a profit. RUT was around 1140.00 when this trade went off yesterday so that involves the index dropping more than 12%. There is nothing holding the trader back from exiting the trade early and that is a distinct possibility. Keep in mind, based on history if we do get a dramatic drop in RUT the implied volatility of RUT options will be expected to move higher. Just like VIX and the S&P 500, the CBOE Russell 2000 Volatility Index (RVX) and RUT have historically displayed an inverse relationship. A drop in RUT and a rise in RVX would be a positive combination for the holder of this position.
After having a spectacular 2013, RUT has underperformed relative to other broad based market indexes. This can be thought of as bearishness on smaller stocks or bearishness on the US economy. Whatever the reason a big price move lower for RUT is needed for this trade to work out. The chart below shows RUT through yesterday and the line on the bottom shows where the breakeven at expiration is for this tr