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Why Selling RUT Options Would be a Mistake

|Includes: SPDR S&P 500 Trust ETF (SPY)

As a mentor the product that my students love to trade more than any other product is probably the Russell 2000 index, the RUT. However, I have been expressing to many of my students that the RUT is a very dangerous sale right now. That is because the RUT has been flying. No product has been causing more consistent problems with my students. The product has had IV fall over the last few weeks, at the same time while the other products have been moving at a snail’s pace; the RUT has managed to continue to move. Then today, it moved 2%. When using the RVX the ATM straddle is implying about the same standard deviation (40.7 vs. 40.6) at the close of today vs. close of day Friday. When we only use the ATM implied volatility of the April expiration, the increase in today’s IV is even more dramatic. The RUT April 630’s which were ATM on Friday had an IV of about .2132 (including the weekend decay added back in). Today, the RUT April 640’s have an IV of .2159. I should not even need to run the math on the standard deviations the IV’s speak for themselves. Every trader can take something from this observation.

1.) Do not trade without thinking. The RUT’s IV is low relative to how active the underlying has been. The other indexes have had falling IV’s as well, but have not been moving. LOW IV low VOL, that’s okay. However, the WORST combo for a premium seller is low premium high underlying gyration, exactly what the rut is doing.

2.) Last week at this time I was discussing the market confirming the rally. This is because IV was falling as the market rallied. When ATM IV is increasing and the underlying is rallying this is a very strong contradicting signal. I am not calling a selloff, just saying it could be some sort of top here. This is the opposite of that.

3.) What is so awful about long gamma? I really like the concept of selling extra puts and calls to pay for ATM options in some form or another. Basically, I would want to own RUT options.

Disclosure: I am short RUT deltas and Short RUT Premium