Small caps have lagged in the past few months, and one trader is looking to play the group for another move lower.
After surging postelection, small-cap stocks have traded in a range since December. But Todd Gordon of TradingAnalysis.com says not only is that range about to be broken but small caps are about to head lower thanks to how the S&P 500 has been moving.
"What you'll see is the [small caps-tracking ETF] IWM has been in a pretty good period of consolidation while the S&P [continued] to make new highs and just recently has begun to back off," Gordon said Monday on CNBC's "Trading Nation." "[The index is] acknowledging what small caps have been saying."
In other words, large caps are confirming the weakness seen in the small caps — which suggests yet more weakness for the smaller stocks.
Specifically, Gordon thinks that in the short term, IWM could fall back to near its 2015 high of around $129. This means that Gordon believes IWM could tumble 4 percent from its Monday levels, dropping back to levels unseen since November.
To trade IWM on a move down, Gordon wants to buy the May monthly 132-strike puts and sell the May monthly 129-strike puts for 83 cents, or $83 per options spread. If IWM were to fall and close below $129 on the May 19 expiration, Gordon would rake in the maximum profit of $217 on the trade.
But if IWM were to close above $132 on May 19, Gordon would lose the $83 premium he paid to put the trade on. In order to decrease the likelihood of that event, Gordon plans to exit the trade if the "put spread" loses about half of its value — that is, becomes worth about 40 cents.
In that case, Gordon would conclude that "the trade is obviously not working, and the Russell [2000 small-cap index] is either staying in that range or has even moved higher."
