The tough week for stocks was harder on small caps than large caps as the Russell 2000 (RUT) was down 4.43% and the Russell 1000 (RUI) dropped 3.63%. RUT has a lot of work to do to catch up with RUI as the gap is at almost 3% between RUI (down 1.92%) and RUT (down 4.83% for the year).
We tend to see VIX rise relative to the CBOE Russell 2000 Index (RVX) in times of turmoil. That happened in August to the point of historically extreme relative RVX – VIX levels. This week the RVX to VIX premium dropped, but only to 15%, not nearly the levels experienced just a few weeks ago.
I was looking over block trading activity for Thursday and came across a purchase of 40,000 IWM Jun 80 Puts at 0.76. This trade occurred when IWM was quoted at 114.07. See the payoff diagram below and note over a 30% drop in small caps is needed for this trade just to break-even.
When I see large blocks in broad based equity ETFs I say to myself, “Self, why would someone do that where they can trade index options?” Then I take a look at a comparable trade in the corresponding index series. In this case the corresponding index is the Russell 2000 (which is kind of appropriate since that’s what this blog is about) and a comparable trade would have been buying 4000 of the RUT Jun 800 Puts at 6.75. The payout for this trade at June settlement appears below.
I’m going to assume the commission for the 40,000 lot in IWM is higher than the 4,000 lot in RUT options. But there’s also the case of cash settlement. If the market really takes a dive and the Russell 2000 is under 800 at June expiration the result is a cash payment to any buyer of these options. The outcome for IWM under 800 would be a sale of shares of IWM and a resulting short position. I can only assume that a trade like this is done as a hedge against some sort of market catastrophe and as a portfolio hedge I think receiving cash instead of a large short position in IWM would be a preferred outcome.