The recent market movement in U.S. equities has been nothing short of historic, with the Russell 2000 surging approximately 3.5% while the S & P 500 experienced a nearly 1% drop. This divergence has led some investors to question whether this is merely profit-taking in the Magnificent 7 or if it signals the end of the megacap secular trend. In my analysis, I believe that it could be a combination of both factors.
For years, the small-cap index has lagged behind the megacap-driven S & P 500. However, the recent surge in the Russell 2000 may indicate a shift in market dynamics. It is now possibly an opportune time to consider owning the iShares Russell 2000 ETF, especially with the potential for minimal cost involved. The benefits of small-cap stocks seem apparent, particularly in light of the cooler-than-expected June consumer inflation report, which could prompt the Federal Reserve to begin its interest rate cutting campaign in September.
One possible trading strategy to capitalize on the potential upside of the iShares Russell 2000 ETF is through a risk reversal approach. This involves selling the IWM 8/30/2024 $213 put for $5.40 and buying the 8/30/2024 $215 call for $5.65, resulting in a net cost of $0.25 per one lot. While this strategy allows traders to establish a view at low to zero cost, it comes with the risk of owning the underlying asset. However, the opportunity to offset the cost of owning an upside call lies in the premium collected from selling a put.
In the event that the iShares Russell 2000 ETF does not move higher, investors must be prepared to potentially own IWM for a longer-term play. Nonetheless, given the current market conditions and the likelihood of mean reversion at some point, owning small caps could prove to be a rewarding decision. It is essential to consider the risks involved in such a strategy and be aware of the potential outcomes.
It is important to note that all opinions expressed in this analysis are solely those of the author and do not necessarily reflect the views of CNBC or its affiliates. Investors should carefully consider their individual circumstances and seek advice from financial advisors before making any decisions. While the iShares Russell 2000 ETF presents a compelling opportunity, it is crucial to conduct thorough research and due diligence before proceeding with any investment strategy.