Income Trade in IWM (RUT)

[Steven Place]

If you don’t get this today, no worries wait until Monday

The Russell is close enough to 1200 to consider a scaling butterfly trade.

This was talked about in the market wrap from December 18th.

The plan here is to buy some butterflies, and as the RUT continues to run, we will add to the trade.

The chart above has something called a “fibonacci extension.” Basically it compares the previous rally to the current one. The reason I’m putting this on is because I wanted to ask myself “what if we saw another rally like we did in October?

If we saw the equivalent move, it would take the RUT to 1287. I don’t think that would happen, because we didn’t see the same kind of pullback as we did in September.

I think a good target and resistance area is going to be right around 1230, so I’ll add to this trade right around that level.

Here’s the initial trade:

Buy to Open RUT Feb 1130/1180/1230 put butterfly for 9.50

At most I’d pay 10.00 — there’s no reason to force this order in, so float bids out to see if you get filled and walk them up in .10 increments.

I know that the RUT options board isn’t that liquid, so here is the equivalent setup on the IWM:

Goal here is 20% return on risk.

We will add another round of flys if the RUT runs to 1225 or sells off into the 1160’s.

[Steven Place]

OK this next adjustment is going to be a bit tricky because it will depend on your position sizing and whether you are in RUT or IWM.

Basically, the market pullback has worked out great for this trade, but there is plenty of time left to milk some profits.

The problem is the negative delta in the trade. If the RUT rips higher (again) then we lose all profits in the trade and end up having not the best risk on.

The best play here is to reduce delta exposure while keeping the time decay high.

I’m trading the greeks on this, and not the chart.

The best way (that I see) to reduce your delta while keeping theta high is to buy March call spreads.

A call spread is where you buy a call and sell a call, with the sold call having a higher strike.

The trick here is to figure out what strikes to choose to get your delta down.

To do this, figure your your NET DELTA on the trade. You can do this in thinkorswim– I currently have a net delta of -17, which is equivalent to -170 on IWM so we’ll use that.

(Remember, we can use RUT and IWM interchangeably, and the RUT is 10x the size of IWM).

Next, I’ll go to the IWM chain and figure out what I need to get flat.

First, I will buy the Mar 120 call, which has a delta of +45.

Next, I will sell the Mar 125 call, which has a delta of -26.

Total cost per spread is 2.05.

KEEP IN MIND: The butterfly is in February options, and we’re opening up call spreads in March. This is done to reduce theta losses on the call spread.

When I combine the two into a spread, that turns the total delta in the trade to +19.

So all I have to do is buy 9 of these, and my delta is reduced from -170 IWM deltas to 0 deltas.

You can use this same spread and buy as many as needed to get to 0. It doesn’t have to be perfect and you can still be a little net short, but this is a good solution.

Here’s what the risk looks like afterwards:

The gameplan now is to let it simmer for a while. If 1150 is tested, then we can add another round of butterflies, and if 1210 is tested, we can close out the call spreads for a profit and add another round of flys.

[Steven Place]

Going to take profits on this entire trade. The ECB stuff is overnight and I want to ring the register here.

Sell to close RUT Feb 1130/1180/1230 put butterfly @15.95

Sell to close IWM Mar 120/125 call spread @1.25

Total return on risk is 25%

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