Back Derivatives Strategy

A Costless Option Trade to Position for Small Caps (IWM) Underperforming Large Cap Tech (QQQ) After a Sharp Outperformance

Published on October 17, 2025

Jeff Jacobson

We have been struck by the divergence between Small Caps (IWM) and Regional Banks (KRE), two sectors that have traditionally traded very closely. The Portfolio Strategy team ran a decomp of small cap returns since the beginning of September, and returns have been dominated by Cap Goods, Health Care, Software, Tech, and Utilities. Simultaneously, it appears that unprofitable small caps have been substantially outperforming profitable small caps as well. They believe this is the AI trade moving into the more speculative (unprofitable) part of the AI food chain.

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They feel that the unprofitable, AI-driven, small caps will be particularly sensitive to any AI comments from hyperscalers in their upcoming earnings releases. The Strategy team covered the cross-asset implications of any potential negative comments yesterday (HERE), given market concentration and the lack of economic data. We don’t have any reason to expect negative comments, but market concentration warrants risk management, in our view. The market backdrop sets up an interesting scenario in which small caps underperform if any of the hyperscalers disappoint (or the AI trade sells off for any reason).

Against this backdrop, not only have we seen the small caps outperform the large-cap tech names (QQQ) of late, but we have also seen QQQ 3-month 25-delta put vol move up relative to the same duration/delta IWM puts. Given the strategy team view that they would expect small caps to meaningfully underperform on an AI-related selloff, and skew having moved in favor of IWM (IWM puts have gotten “cheaper” to QQQ puts), I like the setup here of selling QQQ puts to buy IWM puts on a costless basis. If tech doesn’t selloff, then the trade is a wash since the QQQ put sale has financed the IWM puts.

Trade:

Sell QQQ Jan 564.78 puts 1x
Buy IWM Jan 230 puts 2.3x
Trades for EVEN (QQQ 600 and IWM 244 refs)

Trade Details:

Selling the QQQ Jan 28-delta puts to buy the IWM Jan 28-delta puts on a costless basis
IWM had outperformed QQQ by over 8% off the lows and is now starting to underperform
Put skew has tightened (QQQ vol has gotten more expensive vs IWM), which also makes the trade setup more favorable
Portfolio strategy team believes we should expect to see IWM meaningfully underperform on either a risk-off trade (due to higher beta) and/or a tech/AI led decline (given the unprofitable AI names that have led IWM higher as of late)
If neither declines then trade is a wash given costless nature
Please contact me or the 22V sales desk for updated pricing and execution

We have seen QQQ put implied vol move up vs IWM put implied vol AS IWM has outperformed (bottom chart)

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IWM/QQQ relative spread rallied by as much as 8.4% off the August lows and is now moving back lower

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