Track That Trade 110622 Mixed RUT and IWM Options

The Trade

Note: This trade was chosen because it requires an immediate adjustment. Please understand that this is not a trade designed to make money. Let’s assume that we made this trade earlier and that the market has moved against us. Let’s also assume that this is an appropriate time to make an adjustment. Obviously each trader finds his/her individual adjustment point, based on his/her risk tolerance etc.

Sold two RUT Aug 820/830 spreads. Premium: $4.10
Bought 3 IWM Aug 81 (equivalent to $0.3 RUT Aug 810) calls @ $238 apiece

Delta of the 820 C is 42, and that’s too high for most traders. The only traders who would still be comfortable holding this trade unadjusted are those who do not adjust before the short option moves into the money. I tried that approach at one time and found it too uncomfortable for my personal style. It’s one alternative, but I do not recommending waiting that long before adjusting a position.

The Adjustment

Next an adjustment was made, using IWM options.

This was done at the request of a Gold Member. It is appropriate for those who trade very small size and prefer to trade 2-lots of RUT, rather than 20-lots of IWM (due to commission savings). For that to be viable, it must be possible to adjust using the smaller IWM options.

One item worth noting in the graph – is that owning the equivalent of 0.3 extra RUT Aug 810 calls changes a big upside move from a money loser to a money maker. However, owning those three extra IWM calls does require paying a decent debit ($over $700 in this example).

This trade provides an opportunity to discuss how to tackle these ‘mixed underlying’ combinations. ‘ This is obvious, but is worth stating.

  • The two different underlying assets must be essentially 100% correlated.
  • IWM is an ETF that is constructed to track the performance of RUT, but is one tenth the size
    • Thus 10 IWM contracts performs very nearly the same as one RUT contract
    • However, IWM is American style and expires Friday afternoon, while RUT is European style and settles Friday at the opening of trading
    • Thus, it is MANDATORY that this combination be closed no later than Thursday, one day prior to the 3rd Friday of the month

One extra warning. DO NOT get fancy. Do not try to save even more on commissions by using leveraged ETFs or their options. Leveraged ETFs have a design flaw, and owning them is a bad idea.

Note: The x-axis is in % movement. That’s necessary when we have more than a single underlying asset being plotted

The Greeks

The data considers one delta as one delta. In other words, one IWM delta is the same as one RUT delta in the numerical data above the graph. Thus, these numbers must be adjusted.

IWM greeks must be divided by 10. Then they can be combined with RUT greeks to give you accurate greeks for the combined position.

Example: Theta

The data shows the position as having -4 theta. However, IWM is -7 theta and we know that is really only -0.7 in ‘RUT’ terms. This the overall position is still positive theta (+4 from RUT and minus less than one from IWM).

Example: Delta

The dats shows total delta to be +127. However, that is not accurate. IWM delta is +139, and that translates into +14 RUT delta. Thus, this position is now long 2 delta. That suggests the adjustment is too large. Below, we examine buying only one IWM call option.

Please note that this correction is not necessary for the risk graphs. Those are plotted in DOLLARS and the graphs represent the true picture (or as true as possible when recognizing that each of the greeks is an estimate).

Smaller adjustment

Buying only one call instead of three produces a much flatter graph. Delta is now -7.

But that’s good enough. The objective of owning the extra call option is to minimizes upside pain, it is not to profit on a rally. If you want a bullish play, this combined position is not a good choice.

3 Responses to “Track That Trade 110622 Mixed RUT and IWM Options”

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