By Chris McKhann
The Russell 2000 is climbing to new highs, but a huge call spread appears to be calling a top for the small-cap index.
The RUT is up to about 861, just off all-time highs this morning that exceed levels from 2007. The index bounced off support at 820 last week and has been trending higher since levels around 600 just eight months ago.
The index options for the RUT are actively traded, but nowhere near those of the SPX or VIX. This morning's volume of more than 71,000 contracts is well more than the daily average. This volume is almost entirely in one May call spread.
More than 33,000 each of the 910 and 920 calls have traded, far exceeding the previous open interest at both strikes. The largest blocks in each of 19,000 saw the 920 calls go off for $0.30 and the 910 calls for $0.60.
There is no single underlying as this is an index, so no direct hedging. But many traders like the indexes for iron condors and other credit strategies. It does appear that that this is a credit spread, with the 910 calls sold and the 920 calls bought as an upside hedge. And this may well be a newsletter recommendation, though one with a large following.
This type of trade has a high probability of profit. Taken from the delta of the options, the probability that the RUT is above 910 at expiration is just 5 percent. And there is only a 3 percent probability that it is above 920, but the spread only takes in $0.30.
If the RUT is above 920 at expiration, the potential loss is $9.70. While most such traders believe they can avoid the maximum loss, they also typically use heavy leverage, as the $0.30 isn't that attractive on its own.