With Friday’s euro summit-induced rally, it appears the market switch has been flipped back to “risk-on.” Such is true particularly with the small-cap-laden Russell 2000 (RUT). For charting purposes, I’ve elected to use the exchange-traded fund for the Russell 2000 Index, the iShares Russell 2000 Index ETF (NYSE:IWM). From a technical viewpoint, Friday was notable for three reasons.
Click to EnlargeFirst, the IWM established itself firmly back above the pivotal 50-day moving average, which is a smoothing mechanism many technicians look to as an indicator of the intermediate trend.
Second, the launch occurred on the highest volume seen during an up-day since Feb. 3, 2012. The higher volume indicates institutional accumulation that has otherwise been absent during the recent market swoon.
Finally, the prior highs of June 19 have been breached, resulting in the formation of yet another higher swing high, revealing a firmly entrenched, short-term uptrend.
Given this hat trick of bullish developments, the odds of the Russell 2000 index cracking below the June 4 lows of 730 over the next month are quite slim. Traders willing to take this bullish bet might consider selling the RUT August 720-710 bull put spread for $1.10 or better. The bull put spread consists of selling to open a higher-strike put while buying to open a lower-strike put in the same expiration month. The max reward is limited to the initial credit received at trade entry and will be captured provided the puts sit out-of-the-money at expiration. The max risk is limited to the distance between strikes minus the net debit and will be incurred if the stock sits below the lower strike put at expiration.
Provided the RUT remains above 720 by August expiration, the suggested bull put spread could yield $110. If the RUT falls beneath 710 by August expiration, the potential risk stands at $890.
Given the sharp advance last week, the market might be due for some consolidation or a slight pullback. If a retracement plays out in the coming days, traders should be able to sell the August RUT put spread for even more than $1.10.
At the time of this writing, Tyler Craig held neutral positions in Russell 2000 Index options.