IWM, RUT Highs Spark Demand For Call Options

Pent-up short interest could fuel gains on the Russell 2000 Index (RUT)

Feb 16, 2017 at 12:04 PM
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According to BofA-Merrill Lynch, capital inflows on small-cap stocks increased last week for the first time since the U.S. presidential election. At the same time, investors unloaded mid- and large-caps. Against that backdrop, options traders have been targeting the iShares Russell 2000 ETF (IWM) and Russell 2000 Index (RUT).

IWM hit a record high of $139.84 earlier, but was last seen off 0.6% at $138.80. While the $138-$140 region has been a tough nut to crack, the small-cap exchange-traded fund (ETF) is still sitting on a 38% year-over-year gain. Amid this prolonged stretch of technical strength, out-of-the-money (OOTM) call options have grown increasingly expensive. Specifically, the 10-day moving average of the put/call skew measuring IWM options at least 5% out of the money is nearing an annual low.

Meanwhile, for RUT, its 10-day call/put volume ratio at the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) sits 1 percentage point from an annual high, at 1.33. Echoing this, the index's Schaeffer's put/call open interest ratio (SOIR) sits at a 12-month low of 1.26, meaning open interest among short-term options is far less put-skewed than usual.

Yesterday, in fact, volume on RUT call options hit an annual high of 162,829 contracts, bringing call open interest within 1 percentage point of a 52-week peak, with 287,383 contracts in residence. That said, Wednesday's big options trade consisted of a 38,305-contract block of March 1,490 calls sold to open, along with a matching lot of March 1,510 calls that was purchased. According to Trade-Alert, this bear call spread suggests the options trader is skeptical of RUT's ability to reach the 1,490 level by the close on Friday, March 17, when the soon-to-be front-month strikes expire. If this happens, the trader will collect a cool $1.7 million.

Like its aforementioned ETF, RUT has been hitting record highs lately, peaking yesterday at 1,405.21, but last seen 0.8% lower at 1,393.10. Interestingly, though, of the indexes Schaeffer's Quantitative Analyst Christ Prybal surveyed, the Russell 2000 was the only one that saw a short interest increase in the latest reporting period. Also, the percentage rank for short interest on RUT stocks has been far higher over the past one year and five years than that on the larger indexes. This suggests that small-caps could still have more gas left in the proverbial tank, via short-covering activity.

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