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RUT vs. SPX risk/reward

Discussion in 'General Discussion' started by DavidF, Apr 11, 2016.

  1. DavidF

    DavidF Well-Known Member

    I traded an iron fly M3 & unhedged M3 (100 point wings) on SPX the last 6 months and it pretty much sailed through the period from Dec to March. I don´t remember much stress or drawdowns. The set-up was very similar to Jim Riggio´s Kevlar trade plan (you can see how good his results were in this period with minimal adjustments/drawdowns).

    Now that I have OV backtesting and run a similar set-up on RUT I see why a lot of much more experienced traders had problems trading the small cap index, i.e., the move down and back-up spanned about 46% versus 25% for the RUT and SPX respectively.

    Is this period an anomaly? Otherwise I don´t see why you should take the risk on RUT as the BF premiums don´t compensate for the extra volatility. Looking back through historical data I can´t find a period where it was advantageous to trade RUT vs SPX.
  2. AKJ

    AKJ Well-Known Member

    There are two things that I think are important in determining which index will serve as a better underlying vehicle for income trades.

    First is the Volatility Risk Premium - or how much higher the IV is than Realized Vol. Over time, 30-day realized vol in both SPX and RUT have been ~3.25 percentage points below the VIX and RVX. Over shorter periods however, I may detect some cyclical leadership in one of the indices, and thus favor that index over another. Ultimately, it is unknowable ex-ante if realized volatility over the life of a trade will be higher or lower than the IV I am collecting as a seller of theta; I must therefore make an educated guess as to which underlying vehicle offers the best expected vol risk premium, and try to construct a trade in that vehicle accordingly.

    Second is the affinity for one index to experience stronger trends than the other. In income trades, I find that trends in the underlying vehicle are a central source of losses/drawdowns. Alternatively, mean reversion in the underlying is a central source of profits. Once again, it is unknowable ex-ante if one index will experience a stronger trend than the other (in vol adjusted terms), but I try to make an educated guess based on historical statistics and some Technical Analysis 101, and favor the vehicle that I believe is less likely to enter a strong trend.
    Last edited: Apr 11, 2016
    DavidF and Andrei like this.
  3. DavidF

    DavidF Well-Known Member

    Thanks for your input Andrew, agree on both points.

    However with respect to risk premium (maybe it´s just spurious) but using spot checks on select dates I find that the RUT BF´s do not compensate for the larger moves vs. SPX.

    Aug24th is a very good example but the pricing is so wild it may be off

    But let´s take Jan 4th 2016, end of day (21.00). RUT is down 2.8% for the day and I place a 50 point wing BF 2% (20 points) under the money. I get approx. 7.4% of downward movement before that fly starts losing money.

    Do the same on the SPX which is down 2.5% on the day. I place a 100 wing BF 2% (50 points) under the money. I get 11.4% downward movement before that fly loses money.

    Why does the SPX fly give me much better downside protection than the RUT? Especially when RUT went on to lose about 20% from 1st Jan to 11th Feb whilst SPX lost only 13% or so.
    Last edited: Apr 12, 2016
  4. AKJ

    AKJ Well-Known Member

    RVX has historically been ~5.8 points above VIX. On 1/4/16 (at 15:30 ET) RVX was 23.48 and VIX was 22.17 (according to IV). RVX was only 1.3 points above VIX at this time.

    Relative to historical levels, I would interpret this to mean SPX IV is rich relative to RUT IV. I would prefer to sell the rich IV versus the cheap IV.

    If you are deciding which underlying to trade in, this may be one data point to help determine which index is giving you better value.

    The other factor which contributes to the downside breakeven being further away in SPX versus RUT is the skew. SPX skew was steeper at this time than the RUT skew, giving you more room to the downside before you would need to adjust. If the conditions were flipped and RUT skew was steeper, then I would expect the downside breakevens to also change.
    Last edited: Apr 12, 2016
  5. DavidF

    DavidF Well-Known Member

    Thanks Andrew. So regarding your last point on the skew, you mean you get the lowest leg of the SPX fly cheaper relative to the other legs vs. RUT?
  6. AKJ

    AKJ Well-Known Member

    Actually, no. The lowest leg gets more expensive and increases in price the most when the skew steepens. Still, the fly is cheaper because you receive more credit for the center strikes and have to pay less for the upper long.
    Shin and DavidF like this.
  7. Boomer34

    Boomer34 Well-Known Member

    Great info guys...keep talking...I'm learning a lot with this exchange!

    Andrew...any examples with graphs?

    Thanks again!
  8. AKJ

    AKJ Well-Known Member

    Hi Boomer,

    For charts and analysis involving SPX, RUT, VIX, and RVX, I would encourage you to pull the data from Yahoo Finance (or any other available free data sources) and try to replicate yourself. This may be more illuminating than having me post a bunch of charts. If you have questions or are unable to reproduce, feel free to DM me and I will try to help.


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