Name That Trade $IWM: Russell, Your Looks Have Become A Problem

by Dan September 27, 2013 1:19 pm • Commentary

Earlier today there was a trade in the IWM that caught my eye (I will discuss below), largely because the small cap ETF that mirrors the Russell 2000 index has shown very dramatic relative strength to the SPY of late.

The IWM vs. SPY ratio is nearing all-time high, which was achieved in  2011 (below) .

IWM vs SPY ratio from Bloomberg
IWM vs SPY ratio from Bloomberg

This could pose as a possible area of resistance, meaning fund managers could start rotating out of small caps and back into large caps given  the extent of the out-performance.

The one year chart of the IWM is a work of art, rally, consolidate, breakout, wash rinse, repeat.  The entire time it has held the uptrend that has been in place since the Nov 2012 lows.  The chart below shows the etf consolidating above the previous highs making a very attractive bull flag, up 28% on the year, dramatically outpacing the SPX up 18.6%.:

IWM 1 yr chart from Bloomberg
IWM 1 yr chart from Bloomberg

So the trade below was a Put Butterfly, where the trader defined the range where he could make or lose money over a defined period of time with defined risk.  What I really like about the trade is how the strikes correspond with really important technical levels.  Let’s look at the trade first, that traded midday 15,000 by 30,000 by 15,000 contracts:

TRADE: IWM ($106.70) Bought Oct 105/100/95 Put Butterfly for .60

-Bought 1 Oct 105 Put for 1.10

-Sold 2 Oct 100 Puts at .30 each or .60 total

-Bought 1 Oct 95 Put for .10

Break-Even on Oct Expiration:

Profits:  gains of up to 4.4o btwn 104.40 and 95.60, with max gain of 4.40 at 100

Losses: up to .60 btwn 104.40 and 105 and btwn 95.60 and 95, max loss of .60 above 105 and below 95

MY VIEW:  Despite this trade having a break-even that is 2% lower, the trade defines a period where there could be some fireworks with the looming govt shutdown and debt ceiling debates, as Treasury Secretary Lew recently stated that Oct 17th could be a drop dead date for the debt ceiling.

Additionally when you look at the chart above, $105, the strike the trader is long was the recent breakout level, while $100 is a nice intermediate support level which would also represent about a 6.5% pull back.   This seems like a very reasonable target  heading into a period that will incorporate Q3 earnings, abundant geopolitical noise and the mess in Washington. On the other hand, any resolution to the issues out of DC and this is a .60 loss. But it’s much better than being short the ETF on the business end of a squeeze higher on good news.