The Week in Small Cap Stocks – 3/16 – 3/20

Small cap stocks widened the lead against large cap stocks for 2015 as the Russell 2000 was up 2.78% while the Russell 1000 advanced by 1.95% last week. That places the Russell 2000 up 5.12% while the Russell 1000 is now up 2.96% for 2015. The volatility markets diverged a bit from the small cap outperforming large cap stocks as the large cap focused VIX lost 18.63% while the CBOE Russell 2000 Volatility Index (RVX) was down 16.48% for the week. Despite this the RVX / VIX spread remains a low levels when compared to 2014 where the risk perception of small cap stocks was justifiably higher than the risk priced in for having large cap exposure. I say justifiably high as small cap stocks spent most of 2014 underperforming large caps. The chart below depicts the daily spread between RVX and VIX depicted as the ratio of RVX divided by VIX from the first day of 2014 through Friday March 20, 2015.

RVX VIX Spread

At least on trader was very bearish on small cap stocks the day after the Fed announcement this past week. I’ve been writing about out of the money option selling or credit spreads in RUT a lot lately, but this week there is someone that took the other side of the belief that a big drop is not on the horizon. The actual trade, which was executed Thursday was a buy of about 3000 RUT May 950 Puts for 0.65 (as a side note – another 2000 were purchased on Friday for 0.55). On Thursday the Russell 2000 closed around 1255, this means the break-even level for this trade involves a drop of over 32% in just under two months. The payoff diagram below shows that a market crash in the next couple of months may result in a nice profit. Of course a 33% drop in the Russell 2000 would have some side effects on the rest of the world financial world. My position is as a market observer, but I can’t help but root against this trade as if it is successful the damage would be pretty extensive.

RUT PO