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As frequent readers of our blog are well aware, the RUT (Russell 2000 index) is one of our favorite vehicles for iron condor trading and serves as the cornerstone of our premium subscription service. It offers tight bid/ask spreads, good liquidity and income tax advantages over IWM, the ETF version of the RUT. And most of the time, the volatility premium provides us with favorable credits.

When markets trend with the kind of velocity that we've witnessed in the past month, it presents some challenges to sellers of options, as implied volatility drops to record lows and the implied volatility premium (the difference between the implied and realized volatility) evaporates.

But markets aren't static. Often as soon as we begin to get accustomed to a particular market condition, those conditions change. In order to put the current RUT behavior in perspective, we looked back at the last time we saw record low volatility, a strong trending market and an oversold condition (as measured by the RSI 14). The most recent example of this condition in the RUT occurred around this time last year.

Starting in mid-December of 2011, the RUT bottomed at 707 and moved up at a 45 degree angle, arriving at 833 at the beginning of February amid overbought conditions and a piercing move through the top Bollinger band. But the market didn't pullback - it simply digested the move over a period of 3 months before correcting in early May.

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While some traders might have waited to see the 3-5% pullback in late February to initiate a trade, watching the volatility trends would have provided an earlier and more profitable entry. As the market digested the move in early February, implied volatility moved to the top of its 30 day range - a striking difference from where RUT 30 day implied volatility current resides (in the bottom 5%).

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The volatility premium also moved into the top of its 30 day range, demonstrating that market demand for downside protection, not simply a pullback in the underlying, can drive significant increases in implied volatility relative to historical volatility. The RUT worked off its overbought condition through consolidation over time, not a dramatic pullback.

The current market behaviors and pacing look very similar to early 2012. History may not repeat but we think there's a good chance for some rhyming in our near future.

As iron condor traders (with short vega), we obsess over volatility, both historical and implied. To put the current volatility in the proper context, we frequently measure the current implied volatility relative to the 30 day implied volatility range. This helps us to structure favorable trades that put volatility trends on our side.

During sustained market rallies like the one we are currently experiencing, implied volatility drops significantly. When we ran our usual implied volatility screen against the top 38 indices/ETFs by option volume, the levels (or lack thereof) of implied volatility were quite telling.

Nearly all of the indices/ETFs, regardless of their correlations to the broader market, are experiencing very low implied volatilities (aka cheap options) relative to their 30 day implied volatility range.

The major ETFs such as QQQ, SPY, DIA and USO all have 30 day implied volatility range readings below 1%. These ETFs also have 30 day implied volatility averages that are less than their 30 day historical volatility averages.

While we don't pick market tops or bottom, the mean reverting nature of volatility tells us that vols may not go much lower. And an uptick in volatility, both implied and realized, means better opportunities for iron condor traders.

Successful market neutral trading assumes that markets don't move in one direction. More often than not, the markets are mean-reverting and spend their time in ranges well defined by support and resistance levels. Trend-based swing traders wait for moves out of these ranges to place their trades, while market-neutral traders rely on the markets' frequent inability to breakout (or breakdown).

A breakout market is the biggest risk to iron condor traders. If they have an open position, they either roll or close, taking the loss with the knowledge that they can establish a new position in the next expiration cycle. But for the trader looking to open a position, the choices aren't always so obvious.

The current state of the Russell 2000 (RUT) is a perfect example. With a 14 day relative strength reading of over 70, it is clearly overbought. Relative to other world markets and indices, it is more overbought than nearly all of them. Looking at the usual array of technical studies from Bollinger Bands to stochastics to distance from various moving averages, the RUT is overbought. And as the old trading truism goes, markets can remain overbought (or oversold) longer than a trader can remain solvent.

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In addition to being overbought, the RUT is sitting at an all-time high. Uncharted territory. A new frontier. There is no group of trapped investors sitting at some level just above the current price who are eagerly waiting to cash out once the index gets a little bit higher. In the absence of classic overhead resistance, what's an iron condor trader to do?

Do you treat the current level as your new mid-point and pick a short call based on your normal criteria (delta, open interest, etc.)? Do you structure your trade with a slightly directional bias? Convince yourself that you can call the direction (and timing) well enough to leg into a trade?

Every trader's approach varies, depending on their time frame, risk tolerance and overall portfolio construction. But a pullback in the RUT at this point would clarify all of the above questions and give traders the chance to determine if the RUT is topping or simply digesting in advance of more upward movement. A pullback, whether met with more of the buying-on-the-dip that has characterized the market over the past several years or the beginning of a more significant move downward, will result in greater volatility premiums, the kind that can make a real impact on a trader's year.

Iron condor traders, especially those who view this style of trading as a monthly income strategy, believe that they need to be in the market at all times. In markets like these, it's better to think like an major league batter and wait for your pitch.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.