During the entire rally in smallcaps, an interesting indicator did something that it wasn't supposed to.
I'll show you what's going on in just a moment, but first let's take a look at where the Russell 2000 (RUT) index currently sits.
Smallcaps had a monster of a rally without any kind of pullback at all. I attribute this to rotation out of high-beta tech and into riskier names.
Because funds need to play catch-up into the end of the year.
Whatever the reason, it was a massive trend with little or no reversion. RUT has had rallies like this only 3 other times over the past decade, and those other 3 times have led to range-bound price action.
Now let's take a look at the indicator that has moved a little unexpectedly.
A Rally Driven By Fear
The RVX is the volatility index for the RUT. It measures the supply and demand for RUT options.
It trades very similar to the VIX-- when the market sells off, investors want to hedge so they buy protection. That rise in demand causes an uptick in volatility markets.
With this big rally in the RUT, you'd expect some kind of big drop in the RVX, right?
Well, here's what has happened:
That's right, as the Russell 2000 Index rallied, RUT options actually caught a bid.
Pretty odd, don't you think? You'd expect that with this kind of rally, investors would be popping champagne and letting their bets run higher.
This tells me that... if investors are buying protection into this rally, any drop in this market will not be a big one.
Think about it-- if you have RUT puts bought, and then the market drops, you will close those hedges. When you close the hedges, the market makers take the other side and then buy the market to get neutral.
This hedge-closing can help to buoy the market.
How To Trade This
Here's what I think will happen:
- RUT starts to establish a trading range as the momentum we saw over the past month is pretty rare and we tend to see the "trendiness" drop.
- RUT options still have a healthy premium
- We probably won't see a massive pullback as buyers will step up and hedgers will close their positions.
That makes RUT a great candidate for Iron Condors.
Iron Condors are a trade strategy where you profit based off a range rather than picking a direction. You can earn consistent returns without needing to try and time the market.
I like starting to sell iron condors in December options-- the premium is high enough and you have plenty of wiggle room in either direction to manage your risk.
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