Russell 2000 Volatility and the Reconstitution Process

June means a lot of things to a lot of people such as kids getting out of school, finally putting away the snow blower in Chicago, or anticipating a well-deserved vacation.  For market watchers June means it is time for the Russell Reconstitution process.

I spend a good amount of time focusing on market volatility, both historical and implied volatility.  Historical volatility can be obtained through a simple calculation on any financial market, whether it is a stock price, index, or even currency exchange rate.  However, there are a limited number of markets that have consistent implied volatility measures available.  The Russell 2000 Index (RUT) is one of the most visible indexes offered by FTSE Russell and it is also one that has an implied volatility measure available for analysis.  The specific volatility measure is the CBOE Russell 2000 Volatility Index (RVX) which uses CBOE’s VIX methodology combined with RUT option pricing to calculate a consistent 30 day measure of expected volatility from the Russell 2000 Index.

Being interested in volatility I decided to take a look at what happens during the month of June when the Russell 2000 is going to through the process of adding some new members and dropping others.  With all the changes going on some market observers may think the Russell 2000 would encounter some unusual or more volatile price action in June.  First I took a look at the realized volatility for the Russell 2000 by month for the last 11 years.   The bar chart below shows the average price volatility by month.

Recon 2

Note that June is highlighted, but other than being a different color, it does not stand out relative to the other months during the year.  In fact, when ranked it is the 6th most volatile month of the year.  Right in the middle of the rankings.   I also took a look at the average for the Russell 2000 Volatility Index by month over the last 11 years.  The bar chart below shows that June is right in the middle of the pack as far as average RVX rankings.

Recon 1

What all this tells me is that the market is aware of the reconstitution process, but the process does not have any impact on the Russell 2000 Index or Russell 2000 Index option pricing.  The result may be a lack of extra volatility that many traders like to try to take advantage of, but that lack of volatility results in a smooth transition for managers charged with matching the Russell 2000 or any other FTSE Russell index.