IWM: Big Bet Against the Small Caps


An impressive spread was opened in the iShares Russell 2000 Index (IWM) Monday. Shares were trading down $0.10 to $90.70 and moving off the multi-year highs set the day before. One options trade surfaced midday that involved a total of 200,000 put options contracts on IWM. The hefty butterfly spread appears to be targeting a substantial decline in the small caps through the remainder of the quarter. While it might have been initiated against a stock portfolio as a hedge, the timing is interesting. One might naturally wonder, why open this massive spread now?

The hefty put fly was in the March Quarterly options on IWM that expire on 3/28 - the last business day of the quarter. In this position, the investor bought 50,000 March 88 puts on IWM for $1.24, sold 100,000 March 85 puts at $0.65 each, and bought 50,000 March 82 puts for $0.35. In other words, the March Quarterly 82 - 85 - 88 put butterfly spread on IWM was bought for $0.29, 50,000X. Today's open interest numbers confirm that a new position was initiated.

The sweet spot of the put butterfly spread at expiration is the middle strike. In this example, the best profits happen if shares fall to $85 by the end of March. If so, the position is targeting a 6.3% drop in the IWM over the next 44 days. At that point, the March 85 - 88 put spread, which was bought, is worth $3. The March 85 - 82 put spread, which is sold, is worthless. The profit is therefore $3 minus the debit paid, or $2.71 per spread. The risk to the trade is that IWM holds above the higher strike (or drops below the lower strike) and the position is left open through the expiration. At that point, the $0.29 debit is lost. The downside breakeven at expiry is at $87.71 (and $82.29).

At the end of the day, more than 227,000 March Quarterly puts traded on IWM, but it doesn't end there. Total put volume in the product was an impressive 647,000 contracts and also included active trading in the March puts, where another 228,000 contracts changed hands. In addition, a similar 133 - 141 - 149 put fly traded in the March Quarterlys on the SPDR S&P 500 Trust (SPY), 30000X, Monday.

While all this put activity in the ETFs is probably designed to hedge other positions, rather than make outright bearish bets, the timing is noteworthy. What is motivating these big players to initiate the trades now, in the middle of February, in options that expire at the end of next month? Clearly they are concerned about some type of event risk that could potentially roil the US equity market in the weeks ahead.

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