RUT Trade Review

by Adam Beaty

Yesterday we opened a trade on the RUT - Russell 2000.  Specifically, did a short vertical put spread using the 805/800 strikes on the May expiration.  What this means is I sold the 805 strike and bought the 800 strike to bring in a credit.  A short vertical put spread is a bullish to neutral play because you will make money if the stock goes up, stays flat, or even comes down slightly.  In our case of using the 805 strike it gave us 3.53% cushion room to breakeven, and the RUT would need to move below 805 by the end of the trading day today (Thursday) for us to lose money.  Now our total credit for this transaction was .22 per spread.  A credit of 22 would mean a 4.6% return on investment for holding the options one day. 

How did we figure out return?

A credit play requires a margin account since you are bringing in money the brokerage will hold the required money until you close the option or it expires.  In this case the amount needed for margin is 478.  Margin can be figured out by:

Strike 1 - Strike 2 - Credit = Margin or in this case 805 - 800 - .22 = 4.78

so our return is taken from the credit received against the money we used to get it, or:

.22/4.78 = .046 = 4.6% return

Okay that covers a credit spread but why did we play the RUT?

From a technical perspective the RUT has been looking like a good short candidate.  It is forming a solid head and shoulders pattern that could be the beginning of a lot of downside.  It was this that I assumed would cause the put prices to be high as people are now buying them to speculate the move downward and to buy protection against their portfolio.  This allowed us to grab a decent return with enough cushion room to have a safe and high probability play.  In the chart the head and shoulders neckline is marked by the line at 815 and our breakeven point is marked by the second line at 805.

We will continue to hold this position for the rest of the day and collect our credit and not have to pay extra commissions to close the position.

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