Why IWM Looks Very Vulnerable to an Expiration-Week Decline

The iShares Russell 2000 ETF (IWM) is an exchange-traded fund (ETF) proxy for the Russell 2000 Index (RUT) -- a prominent gauge of small-cap stock performance. And as compared to proxy ETFs for the S&P 500 Index and the Nasdaq-100 Index (SPY and QQQ, respectively), IWM has been super-charged. To wit, here are the changes for these ETFs from their lows in February and November 2016, respective to their 2017 peaks: IWM (+50%, +23%); SPY (+32%, +15%), QQQ (+39%, +16%). Yet when performance is viewed on a year-to-date 2017 basis, we then have: IWM (+0.8%); SPY (+6.3%); QQQ (+10.9%).

The point here is to Illustrate our assertion that IWM is stretched and overbought compared to its index ETF peers, that this is already playing out in terms of IWM underperformance to date in 2017, and that IWM right now is in a league of its own when viewed through the prism of a potential short-term "accident" to the downside. And while this scenario (let's call it "sharp and unexpected short-term downside") must still be considered unlikely to play out over the course of March expiration week, there is reason to believe that the chances for it so doing are elevated (and perhaps significantly so).

March options expiration is a "big deal" for IWM. An extremely robust 38% of all IWM option open interest lies in options expiring this week -- as compared to just 29% for SPY and 28% for QQQ. And while everyone knows that put open interest vastly exceeds call open interest for these index ETFs, the trends for these call and put open interest levels are upside-down for IWM as compared to the benchmark SPY options.

So while the current level of SPY call open interest is in the 39th percentile of all such readings over the past year, IWM call open interest is now in the 80th percentile. And while a 90th percentile reading applies to the current level of SPY put open interest, this level is just 62% for IWM puts (source: Trade-Alert). So while the relative play in SPY puts is near a multi-month high, it is instead the play in IWM calls that owns this distinction. The bottom line is that call option players have, in fact, taken notice of the huge IWM rally from its 2016 lows -- but not so much IWM's poor relative performance in 2017. And with a big March option expiration upon us, the disappointment among these call holders could contribute to an unexpected IWM March expiration week pullback.

It all comes down to the put-heavy March 135-strike level, as in, "Will $135 continue to hold as support (as it has throughout 2017), or will it be seriously broken (and thus create reflexive and heavy short selling by hedgers as these put positions move deeper into the money)?" Because if $135 is broken, IWM will move into clear negative territory for 2017, and likely take out support at $132 (and possibly at $130).

Chart courtesy of Yahoo Finance

Subscribers to Schaeffer's Expiration Week Countdown service received this IWM commentary on Sunday night, along with a detailed options trade recommendation -- including complete entry and exit parameters -- straight from Bernie's trading desk. Learn more about why Expiration Week Countdown is one of our most popular options trading services.