Thursday’s bloodletting was ugly regardless of your vantage point, but it was especially nasty for small-cap stocks.
The iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) fell more than 2% on the day amid heavy selling pressure. Far from a garden variety pullback, the ongoing dive in IWM has dealt damage aplenty to a chart that was once healthy.
Let’s zero in on the price action to assess the aftermath. For brevity, I’ll limit the commentary to the three biggest bearish developments.
- Trendline break. The IWM ETF had been entrenched in a solid uptrend, ever respectful to its sharply rising trendline. Every dip to this rising support level was quickly bought — until yesterday. For the first time since October buyers fumbled. In the process the Russell 2000 ETF descended below the 50-day moving average, turning its daily chart into a full-fledged downtrend.
- Distribution day. The volume amid Thursday’s swan dive was breathtaking to say the least. It seems everyone was participating in the sell-fest. While optimists are hoping the volume signals capitulation, or a washing-out of the weak hands, I’m a bit skeptical. More sellers may be hiding in the weeds ready to pounce on any future rebound attempts.
- Relative strength reversal. The outperformance in IWM staged an abrupt about-face this week. The uptrend in its relative strength reversed course showing the previously leading index is now a laggard.
Bet on the Bears with IWM Call Spreads
Traders looking to capitalize on continued weakness in the land of small caps could sell June bear call spreads on IWM.
By using out-of-the-money options, we can structure a trade that will profit provided IWM doesn’t rally too far from current levels. Sell the Jun $128/132 call spread for 48 cents or better.
The maximum reward is limited to the initial 48-cent credit and will be captured if IWM remains below $128 by June expiration.
The maximum risk is limited to the distance between strikes minus the net credit, or $3.52, and will be lost if IWM rallies above $132. To limit the loss consider exiting if IWM rallies above $127, which is a major resistance level.
At the time of this writing Tyler Craig owned short option positions on the Russell 2000 Index.
