We’re only two days into August, but so far bulls appear to be raising the surrender flag in the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM). And for traders that don’t mind hedging or taking on the occasional bearish position, the time is right for a limited-risk short in IWM.
“Blame it on the rain” as Milli Vanilli once had a nation lip-synching, if you want a reason for Tuesday’s decline in IWM. Alternatively, there’s an assortment of potential maladies that should continue to pressure the Russell 2000.
For starters, there’s persistent weakness in crude to consider as a reason for lower prices ahead in IWM.
With crude futures now below $40 a barrel, traders’ conversations are switching to bearish misgivings related to still at-risk oil and gas operators and other bearish economic consequences.
IWM also faces slumbering of late European bank recapitalization concerns. Those potential problems are just beginning to reawaken following this past week’s financial stress testing across the pond. Or might a second act for Brexit enter the theater of Wall Street?
Another problem for IWM: The fact that bullish investors couldn’t muster up the muscle to support Japan’s latest fiscal stimulus package appears to be a negative tell.
Tuesday’s bearish price action in IWM suggests the easy money “to infinity and beyond!” narrative has worn out its welcome; barring a massive drop of helicopter money from the Plunge Protection Team or other central banks.
IWM Bears also have fairly extreme levels of bullish sentiment in their favor. Following the blink-and-you-missed-it post-Brexit rally, the CBOE Volatility Index has dropped aggressively back to historically complacent price levels.
Last, a survey of active investment managers shows a group that’s essentially “all in.” As a contrary indicator, that can’t be good for the Russell 2000, right?
In all fairness, the historical negative correlation for this survey as it relates to market downswings is far from robust.
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IWM Stock Weekly Chart
It’s been a nice run for investors buying in the immediate post-Brexit markets. Following an extremely oversold condition in IWM and one confirmed by a very panicky VIX index; the Russell 2000 added roughly 12.50% in about 4 weeks time.
It’s been an even nicer year if traders purchased IWM near the oversold February bottom. Shares are up nearly 30% from that low. But now, the Russell 2000 is setting up as a short–and it could be a major one at that!
Along with the current headwinds, a potential, large head and shoulders topping pattern is developing at the 78% Fibonacci resistance level in IWM. Neither is perfect, but in today’s market of lurking algorithms, it’s our view that’s probably for the best.
IWM Bear Put Vertical
In reviewing the IWM options board, the Sept $115 / $110 bear put spread is attractive. Priced for 75 cents, this IWM vertical will breakeven at expiration if the Russell 2000 declines by about 5%. A price drop of about 8% would yield a profit of $4.25 for a return in excess of 550%.
Given September’s bearish historical tendencies and last August’s flash crash, the required moves are made a bit more palatable. As well, prior to expiration, interim profits are possible with lesser movement. Having said that, I’d look to book partial profits on a double or make some other type of adjustment to increase one’s risk-to-reward in a favorable way.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT
