What began last week during a rally in small cap equities coupled with large asset inflows in prominent small cap related ETFs including the gigantic iShares Russell 2000 (NYSEArca: IWM) as well as leveraged long ETF, ProShares Ultra Russell 2000 (NYSEArca: UWM), has shown signs early this week of additional flows.

On Monday of this week, IWM accumulated approximately $500 million in additional assets via creation activity, and UWM took in more than $100 million of assets as well. UWM is structured to deliver two times the daily return to the Russell 2000 Index and is often used by aggressive traders/speculators to leverage upside and magnify potential short term trading returns in the small cap equity space.

We have pointed out on several occasions throughout 2012 that small caps have severely lagged their large cap counterparts for the most part, with the Russell 2000 Index making up more than 300 basis points in under-performance to the S&P 500 Index in just the trailing one month period (IWM +5.17% in past month versus S&P 500 Index up 2.16%).

Year to date, after a very strong August and beginning to September for small cap U.S. equities, the S&P 500 is now only barely outpacing the small cap proxy the Russell 2000 (+14.65% YTD versus 14.07%).

When small cap stocks rally, this is typically seen as a “risk on” trade where investors are comfortable owning higher beta names in their portfolio because they seek higher than average returns.

This said, the relative strength that is appearing in small caps as of late coupled with sizable inflows in long ETFs linked to the Russell 2000 is bullish for the overall market.

From an options standpoint, we have seen mostly put strategies being enacted via IWM options in recent weeks, but this is terribly common since portfolio hedgers tend to use liquid options for basic portfolio protection via IWM, regardless of market conditions and trends.

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