Our put butterfly in IWM expires today on the close. It has been a wild ride this week, with the trade flirting with a loss on several occasions, including this morning. However, today’s reversal has put the trade squarely in the green. We still view IWM as the most vulnerable major U.S. equity ETF, but we’re happy to take the gain on the Sept put butterfly and might re-enter a short-biased options position if IWM rallies back to $117.
Action: Sold to close the IWM ($114.13) Sept 117/110/103 Put fly at $2.85 for a $1.00 gain
In a Chart of the Day post from earlier (below), Enis detailed the re-emergence of the divergence between large and small cap stocks. The inability of the Russell 2000 (we’ll use the IWM) to keep pace with large caps is fairly bearish in our minds, and we want to make a bearish play for a move lower from here with a defined risk structure that avoids decay in this low vol environment:
TRADE – Bought to open the IWM ($115.00) Sept 117/110/103 Put fly for 1.85
– Bought 1 Sept 117 put for 3.04
– Sold 2 Sept 110 puts at .67 (1.34 total)
– Bought 1 Sept 103 put for .15
Breakevens on Sept expiration – Losses of up to 1.85 above 115.15 and below 104.85 with total losses above 117 or below 103. Gains of up to 5.15 below 115.15 and above 104.85.
Rationale – This is a structure that places a bet that IWM could move lower from here with the line in the sand (breakeven) set right near the ETF’s 50 day moving average. The sweet spot on the trade is 110 which is near the recent lows but it does well anywhere below where the stock is currently trading as long as there’s not a crash below the lower breakeven of 104.85 (unlikely)
Today is the second straight day that the Russell 2000 is underperforming the S&P 500 by more than 0.5%. The weakness in the Russell has been a feature of the market ever since many high beta stocks topped out in March, but the most recent bounce has been the most tepid by far for the widely followed small cap index.
Here is a comparison of the return of the Russell 2000 vs. the S&P 500 index so far in 2014:
On both the Feb-Mar rally and the May-July rallies, the Russell 2000 made a catch-up move towards the S&P 500 index. That has been absent so far in the current rally, particularly with the weakness in the Russell over the past two days. Moreover, the small cap index is now negative on the year, after briefly touching green earlier this week.
The IWM/SPY ratio is back near 2 year lows as a result of the weakness in IWM so far this week:
The relative weakness in small caps does not necessarily imply imminent market weakness, as the S&P 500 index has continued higher since March without the small caps in tow. However, it does illustrate the lack of demand for the smaller issues in the market, suggesting that investors are becoming more discerning over the past 6 months as valuations get more elevated.