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The Benefits of Getting Stuck in a RUT


RUT compares favorably with lower-priced IWM as trading vehicle.

As most readers know, I trade RUT. Those are options on the Russell 2000 Index. I've been asked why I don't trade IWM, an exchange traded fund (ETF) that mimics the performance of the same Russell Index.

IWM trades almost exactly at one-tenth the price of its big sister, RUT, and its options have very attractive markets, with the bid/ask spreads being a penny or 2 wide.

Here's a quote screen from Wednesday, April 22, early in the afternoon:

Those are very attractive markets to trade. If these are $0.02 wide, that's equivalent to trading RUT options when the bid/ask spreads are only $0.20 wide. Here are the RUT markets a few minutes later.

As you can see, the RUT markets compare favorably with IWM prices. When the markets were wild, just a few short months ago, I don't know if this was true. Tighter markets, and the probability of getting much better fills (trade executions) would be a good reason to consider trading the options of IWM rather than RUT. There's no advantage at this time.

An investor interested in options on the S&P 500 Index has the choice between trading SPX options, or its equivalent ETF, SPY.

Are there other considerations for making the decision?

1. Small traders may not want to trade as much as a one-lot in RUT, and can invest smaller sums by trading a few contracts of IWM.

2. IWM options are American-style, and RUT options are European-style. If you're not familiar with the important differences between these option styles, check out my previous discussion on this topic.

I prefer trading cash-settled options, so that's a plus for RUT.

On the other hand, those Friday morning settlement prices can be unsettling. My recommendation is to avoid owning positions into that possible chaos, but not everyone does that. American style IWM (or SPY) options expire Friday afternoon, and that's one advantage (assuming you don't mind an expiration that occurs 6.5 hours later). The settlement process is a plus for IWM.

The major advantage of using index options is the special 60/40 tax treatment. Investors get to declare a portion of the earnings as long-term capital gains, no matter how long one owns the position.

On balance, I don't see any substantial advantages to trading the options of the much lower-priced ETF options than trading options on the index. Don't forget than you'd have to trade 10 contracts of the RTF for every one index option to have the same profit potential. For most traders, that means commissions would be 10 times as high. That could be the deciding factor for many.

In memory of our fallen friend and trusted colleague, Bennet Sedacca, 100% of the donations made to the RP Foundation through April will be channeled to philanthropic endeavors consistent with the RP mission, working closely with the Sedacca clan in the distribution of those funds. We thank you kindly for your support as we strive to effect positive change in the lives of children.
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No positions in stocks mentioned.

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