Russell 2000 index options are option contracts in which the underlying value is based on the level of the Russell 2000, the market index most widely quoted when measuring the overall performance of the small to mid-cap common stocks traded in the United States.
The Russell 2000 index option contract has an underlying value that is equal to the full value of the level of the Russell 2000 index. The Russell 2000 index option trades under the symbol of RUT and has a contract multiplier of $100.The RUT index option is an european style option and may only be exercised on the last business day before expiration.
To meet the needs of retail investors, smaller sized contracts with a reduced notional value are also available and goes by the name of Mini-Russell 2000.The Mini-Russell 2000 index option trades under the symbol RMN and its underlying value is scaled down to 1/10th of the Russell 2000.The contract multiplier for the Mini-Russell 2000 remains the same at $100.
|Product Name||Symbol||Underlying Value||Contract Multiplier||Exercise Style|
|Russell 2000 Options||RUT||Full Value of Russell 2000||$100 |
(Full Contract Specs)
|Mini-Russell 2000 Options||RMN||1/10th of Russell 2000||$100 |
(Full Contract Specs)
If you are bullish on the Russell 2000, you can profit from a rise in its value by buying Russell 2000 (RUT) call options. On the other hand, if you believe that the Russell 2000 index is poised to fall, then RUT put options should be purchased instead.
The following example depict a scenario where you buy a near-money RUT call option in anticipation of a rise in the level of the Russell 2000 index. Note that for simplicity's sake, transaction costs have not been included in the calculations.
You observed that the current level of the Russell 2000 index is 429.11. The RUT is based on the full value of the underlying Russell 2000 index and therefore trades at 429.11. A near-month RUT call option with a nearby strike price of 430 is being priced at $28.61. With a contract multiplier of $100.00, the premium you need to pay to own the call option is thus $2,861.00.
Assuming that by option expiration day, the level of the underlying Russell 2000 index has risen by 15% to 493.48 and correspondingly, the RUT is now trading at 493.48 since it is based on the full value of the underlying Russell 2000 index. With the RUT now significantly higher than the option strike price, your call option is now in the money. By exercising your call option, you will receive a cash settlement amount that is computed using the following formula:
Cash Settlement Amount = (Difference between Index Settlement Value and the Strike Price) x Contract Multiplier
So you will receive (493.48 - 430.00) x $100 = $6,347.65 from the option exercise. Deducting the initial premium of $2,861.00 you paid to buy the call option, your net profit from the long call strategy will come to $3,486.65.
|Profit on Long RUT 430 Call Option When Russell 2000 at 493.48|
|Proceeds from Option Exercise||=||Cash Settlement Amount|
|=||(Index Settlement Value - Option Strike Price) x Contract Size|
|=||(493.48 - 430.00) x $100|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Proceeds from Option Exercise - Investment|
|=||$6,347.65 - $2,861.00|
|Return on Investment||=||Net Profit / Investment|
In practice, it is usually not necessary to exercise the index call option to take profit. You can close out the position by selling the RUT call option in the options market. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.
In the example above, as the option sale is performed on expiration day, there is virtually no time value left. The amount you will receive from the RUT option sale will still be equal to it's intrinsic value.
One notable advantage of the long Russell 2000 call strategy is that the maximum possible loss is limited and is equal to the amount paid to purchase the RUT call option.
Suppose the Russell 2000 index had dropped by 15% instead, pushing the RUT down to 364.74, which is way below the option strike price of 430. Now, in this scenario, it would not make any sense at all to exercise the call option as it will result in additional loss. Fortunately, you are holding an option contract, and not a futures contract, and so you are not obliged to anyway. You can just let the option expire worthless and your total loss will simply be the call option premium of $2,861.00.
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