In the markets, periods of expansion are generally followed by periods of contraction.
RUT has been trading higher for 2 months now and is starting to come back towards the middle of the Bollinger Bands.
A strong US Dollar and bullish fundamentals for the markets is likely to provide a floor for RUT. Likewise, after such a strong run-up, significant further upside from here seems limited.
One way to play this view is via an iron condor. An iron condor is an option strategy that benefits from a sideways movement in the underlying stock over a specific period of time.
The trader doesn’t care which way the stock moves, as long as it doesn’t move much.
The downside of the trade is a big move in the underlying will see losses develop. This is particularly true if the move comes early in the trade.
An iron condor has negative vega, meaning that the trade benefits from a decrease in implied volatility.
RUT is an ideal candidate for an iron condor because it tends to have higher volatility than the other index ETF’s. That means options traders receive more option premium, but it also comes with more risk.
A trader wanting to employ this strategy could trade the August 16th 1560-1550 put spread and the 1770-1780 call spread. That trade currently costs generates $235 per contract in premium with a maximum loss of $765.
This trade would need RUT to stay above 1560 or below 1770 at expiry to be profitable. However, profits can be made earlier in the trade, particularly if markets are quiet and there is a decrease in implied volatility.
The chart below shows the profit or loss at expiry.
Iron condors are a great trade for investors expecting a low level of price movement in an underlying stock or index.
