How To Make the Most of Russell 2000 Index Seasonality Through the End Of 2021

In partnership with Cboe™ and FTSE Russell, Russell Rhoads, Head of Research and Consulting at EQDerivatives, is publishing a series of articles about the Russell 2000 Index. In this article, Rhoads analyzes Russell 2000 Index performance and strategies through the end of 2021.

Historically, November and December, are the most bullish pair of months for the U.S. stock market, according to data reaching back to 1989. The most widely followed indices are higher over this two-month period 75% of the time. However, the Russell 2000 Index is the biggest beneficiary of an end-of-year rally, gaining an average of 4.69% over this timeframe, compared to the S&P 500 Index’s average gain of 3.17% over the same period. The chart below shows cumulative Russell 2000 Index performance for November and December over the last 32 years.

Russell 2000 Index November and December Performance 1989-2020

Data Sources: Cboe Global Markets/EQD Calculations

Last year set a record for the best performing final two months of the year since 1989, with a gain of almost 25%. The worst results in recent history were in 2018 with a drop of 11.40%. When approaching a trade, it is helpful to look back at the worst-case scenario, which is 2018 in this case.

Using Historical Data to Hedge Against a Variety of Market Forecasts

Options offer the opportunity to benefit from a wide variety of market forecasts. Keeping the historical data in mind, trades using Russell 2000 (RUT℠) and Mini-Russell 2000 (MRUT℠) Index options offer an opportunity to construct a trade with options that expire on the last day of 2021.

1.      Bull Call Spread

In this example, we’ll use the average move higher of 4.69% to determine a target price or expectation for the Russell 2000 Index at the end of December. On Friday, October 29, the Russell 2000 Index closed at 2,297.19. A 4.69% rise places the Russell 2000 Index at about 2,404 in December. A vertical spread, with defined risk and reward that targets this price, would involve first selling a RUT option December 31 2,400 put at $29.50. Then, compare the $29.50 premium from this option to the time value of in-the-money RUT call options expiring on the same day. The table below lists a few choices for the long call to complete this spread.

Russell 2000 Index Option Long Call Strike Price Alternatives

Data Sources: Cboe Global Markets/EQD Calculations

Selling the RUT option December 31 2,400 call brings in $29.50 of premium, so the 2,130 call would offset all the time value but would allow upside near the target price of $2,404. Purchasing the RUT option December 31 2,130 call for $196.50 results in a trade that costs $167.00 and has a payoff on the final day of the year depicted in the diagram below.

Russell 2000 Index Options December 31 2,130/2,400 Bull Call Spread

Data Sources: Cboe Global Markets/EQD Calculations

The maximum profit for this trade is 103.00 points, which is capped if the Russell 2000 Index is at 2,400 or greater on December 31. The worst possible outcome places the Russell 2000 Index at 2,130 or lower, where losses are equal to the $167.00 cost of the trade. This strategy structure limits losses, which is a benefit if 2018 repeats itself and the Russell 2000 Index experiences a large drop.

2.      Bull Put Spread

Another trade that is not terribly exciting but would be successful in all 32 of the previous years studied, also focuses on the 11.4% drop in 2018 – the worst historical outcome observed. An 11.4% drop from the October 29 close of 2,297.19 puts the Russell 2000 Index at about 2,036 to end 2021. Based on late pricing from October 29, the RUT option December 31 2,030 put could be sold for $17.60. This short put in a bull put spread structure makes sense as the worst drop on record places the Russell 2000 Index just above this price. To complete the trade, the trader would purchase a lower strike put. A few alternatives are listed in the table below.

Russell 2000 Index Option Strike Price Alternatives

Data Sources: Cboe Global Markets/EQD Calculations

There are several other choices, as strikes for RUT options expiring on December 31 go as low as 900, but the put options in the table above are the most likely choices for a trader that does not want to take on substantial risk. The spread credit in the table is the amount of premium and maximum potential profit generated from a bull put spread. The risk is the maximum potential loss at expiration. Each individual must determine their own risk appetite, but for illustrative purposes, we analyzed the outcome of shorting the RUT option December 31 2,030 put at $17.60 and buying a RUT option December 31 2,010 put for $16.10, resulting in a spread credit of $1.50 and a maximum potential loss of $18.50.

Russell 2000 Index Options December 31 2,010/2,030 Bull Put Spread

Data Sources: Cboe Global Markets/EQD Calculations

This trade is safe through the end of the year, so long as the Russell 2000 Index does not drop more than 11.63%, a level that is outside of historical November and December price action. However, just because it has not happened in the past, does not mean a bigger drop is impossible in the future.

Both trading examples are based on nothing more than the performance of the Russell 2000 Index through the last two months of the year going back to 1989. However, they show a high-level method of applying both downside and upside price outlooks to create an option trade in the most bullish months of the year.

Learn more about Russell 2000 Index options and Mini-Russell 2000 Index options >>>

Contact the author at [email protected].

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