Trader buys 'disaster insurance' on this index

After widely underperformed the broader market this year, small caps are suddenly hot. The Russell 2000 rallied more than 1 percent in the last month versus a flat S&P 500, but, one trader made a massive bet that the run will soon come to a disastrous end.

On Monday, the trader bet more than $20 million that the IWM, the Russell 2000 ETF will fall 25 percent by the second quarter of next year. The trader bought 110,000 May 107/90 put spreads for an average price of $2.10 each. This is a bearish strategy where a trader will buy a put and then sell a lower strike put of the same expiration to offset the cost. The goal is to target the strike you are short, or in this case for the IWM to fall as low as $90 by May expiration. That's a 25 percent decline from the ETF's current stock price of just under $120 a share.

Read More The last few times this happened, stocks tanked

"The size of this trade is impressive," Optimize Advisors co-founder Mike Khouw told CNBC's "Fast Money" on Tuesday. "It looks like disaster insurance."

The Russell 2000 has struggled to make any meaningful gains this year. The small cap index is flat while the larger cap S&P 500 and the Nasdaq composite are up a respective 2 and 9 percent.

"The interesting thing is the Russell 2000 would need to fall 12 percent for this to even begin to see profits, but they see the most money if it falls 25 percent, and if it did, they would make nearly $200 million," added Khouw.

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  • Melissa Lee

    Melissa Lee is the host of CNBC's “Fast Money” and “Options Action.”

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