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JPM Trade Reco: "Go Long Russell, Short S&P Via Futures Or Total Return Swap"

It is unclear if JPM's trade recos to clients (as opposed to its prop, pardon flow, traders who traditionally take the other side of client trades) have a comparable track record as those say of ex-Goldman's FX wunderkind, Tom Stolper, or the author of the market's most "valuable" newsletter bar none and whose daughter, Courtney, works at CNBC, Dennis Gartman, but for those who wish to experiment, now is your chance.

Moments ago JPM's Equity and Quant strategy team released a trade reco to buy the Russell 2000 and short the S&P 500 via derivatives.

From the note:

We favor small-cap stocks over large caps in the US as a convergence trade, following their strong underperformance in 2014, based on the following thesis:


Small caps have materially lower foreign revenue exposure than large-cap stocks, and should benefit in relative terms from an environment of strong domestic growth with a strong US dollar (the USD has appreciated ~5% YTD and ~16% over the last 6 months on a trade-weighted basis). Only ~11% of Russell 2000 revenues are derived from abroad vs. ~33% for the S&P 500.

  • Small-cap stocks are sensitive to HY spreads, which have tightened slightly YTD and are expected to tighten further this year, according to our Credit Strategists.
  • Small caps should benefit from an expected pickup in M&A activity this year..
  • Small caps are delivering stronger earnings and sales growth in the current reporting season than their larger peers.
  • The Russell 2000 (small cap index) composition more closely matches our recommended sector allocations.
  • Investors who wish to tilt their portfolios to benefit from the expected outperformance of small-cap stocks could consider the following structures:

Go long Russell 2000 vs. short S&P 500 via futures or total return swap – Russell 2000 futures have traded persistently cheap to fair value due to the high borrow rate on small-cap stocks, while S&P 500 futures have traded rich over the last 2 years as equity financing rates were driven higher by regulatory and industry changes. A long/short trade via futures allows the investor to collect this financing spread, and thus would be expected to yield a positive carry in addition to any outperformance (this carry was ~90bps annualized over the last year based on average futures roll costs). A swap-based implementation of this trade would similarly provide a positive carry, while eliminating dividend and futures roll risk.


Buy a call on the outperformance of the Russell 2000 over S&P 500 contingent on both finishing higher – for example, a 6M ATM call on this outperformance contingent on both indices up at expiry costs ~2.0% of notional indicatively (compared with ~5.5% for a vanilla Russell 2000 ATM call). This outperformance option pays the positive outperformance of the Russell 2000 over the S&P 500, provided that both indices finish higher than current levels. Meanwhile, losses are limited to the upfront option premium paid in case the S&P 500 outperforms the Russell 2000. Figure 73, below, details a few scenarios to illustrate this outperformance option structure. Despite a large differential in relative performance, the correlation between the Russell 2000 and S&P 500 remains high (Figure 74), which benefits the pricing of these outperformance structures (i.e., higher correlation translates into a lower upfront premium for an outperformance option, all else equal).

For those who do put on the trade, or its inverse, please let us know how it ends up (or down).