Weekend Review – Russell 2000 Index and Volatility – 5/9 – 5/13

According to some of the headlines I came across this week, stock market participants are worried about economic growth. This concern about growth showed up in the relative performance of the Russell 2000 (RUT) and Russell 1000 (RUI) this week as RUT was down twice as much as RUI (-1.10% versus -0.54%). This places RUT down a little less than 3% for the year and RUI precariously in the green by a single basis point.

RUT RUI

Concerns over growth continue to show up in the relationship between the CBOE Russell 2000 Volatility Index (RVX) and VIX. RVX is almost always at a premium to VIX, but has remained in the upper 20 to lower 30 percent range more often than not in the past couple of months. This premium remains despite RUT outperforming RUI since the 2016 lows back in February.

RVX VIX

I’m always trying (trying is the keyword as I usually fail) to come up with a new term or phrase that will catch on with market participants. This week’s attempt is the Naked Bear Call Spread in reference to a trade someone executed late Friday. With RUT at 1098.52 a trader came in and sold 125 of the RUT May 20th 1100 Calls for 9.46 and then purchased 125 of the RUT May 20th 1200 Calls for 0.04 and a net credit of 9.42. The payoff at expiration (on the open May 20th as these are standard 3rd Friday contracts) appears below.

RUT PO

The goal for this trade is a May 20th Russell 2000 settlement below 1100. The worst case scenario is a monster rally that takes the Russell 2000 to 1200 or beyond which results in a loss of 90.58. Note that a 9.2% one-week rally is needed for this result to come about. My assumption is the 1200’s were not purchased for protection against that move, but in order to satisfy a risk manager or broker that doesn’t want to potentially unlimited risk associated with a naked short call position.