Trader: Here's a cheap way to play small caps

Here's a cheap way to play small caps: Trader
Here's a cheap way to play small caps: Trader   

Small caps have been making big money this year.

The Russell 2000 index is up 5 percent this year, far outpacing the S&P 500 and Dow returns. Despite the rally, one trader says there is still an inexpensive way to play the sector: the options market.

Implied volatility—a fancy term for the price of options—for small cap stocks has collapsed.

"Ideally you want to be buying that volatility when it looks attractive," said Stacey Gilbert, Susquehanna's head of derivative strategy. Referring the Russell 2000 ETF IWM, she said: "In this particular case I'm defining attractive as IWM volatility has come in at some of the lowest levels in two years."

The decline in options prices reflects growing bullish investor sentiment. According to Gilbert, small-cap stocks owe much of out-performance to one thing: the dollar.

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"If you look back to mid-December, when the U.S. markets had their pullback, you can see right around this time the dollar started to strengthen and we start to see some outperformance in the IWM," Gilbert said Thursday on CNBC's "Trading Nation."

Gilbert says with the dollar showing no signs of slowing down, small caps are likely to remain more attractive than their large-cap brethren.

"This is likely because the S&P 500 companies are much more multinational, with almost a third of these companies receiving significant revenue from overseas compared to the Russell 2000, which tends to be more domestically focused."

Specifically, for those inclined to make a bullish bet, GIlbert highlighted the April 126-strike calls for $1.19. "I'm looking to purchase these calls to give myself the upside exposure," she said.

A call gives investors the right to buy a stock for a set price within a set time. So, in this particular strategy, Gilbert's trade makes money if the IWM rises above the strike of the call that she bought by more than the cost of the trade, or above $127.19 by April expiration.

DiISCLOSURE: Susquehanna is a market maker in the securities of IWM.