Russell Reconstitution: Opportunities to Harvest Volatility

Rick Rosenthal
June 3, 2022

Every year, global data and analytics firm FTSE Russell initiates a multi-week process known as Russell Reconstitution. First, publicly held companies are ranked based on their market capitalizations, narrowing the field to the largest 3,000 companies that represent approximately 97% of the investable U.S. equity market. This group comprises the stocks in the Russell 3000® Index.

The Russell 3000 and its subset indices, the Russell 1000® Index and the Russell 2000® Index, are reconstituted annually to ensure they accurately represent the market performance by each market segment and subsequent investment styles—growth, value, defensive and dynamic. 

Russell Indices

Russell 3000: Broad-based measurement of the 3,000 largest publicly held companies in the U.S. equity market. The average market cap is $471 billion.

Russell 1000: Measurement of the large-cap segment comprised of 1,000 largest securities or 93% of the U.S. equity market. The average market cap is $500 billion.

Russell 2000: Measurement of the small-cap segment comprised of 2,000 companies or 7% of the U.S. equity market. The average market cap is $3 billion.

The widely followed Russell Indices also serve as the basis for measuring performance of investible index products, including index tracking funds, Exchange Traded Funds (ETFs) and derivatives tracking over $10.6 trillion in assets. 

Historically, the Russell Reconstitution process has culminated in the largest trading day of the year. After the reconstitution in June 2021, $186 billion in stocks was traded on the close.

Russell Reconstitution 2022 Timeline

  • May 6: Known as “Rank Day,” index membership eligibility is determined based on constituents’ market capitalization.
  • June 3: A preliminary list of constituent additions and deletions is posted to the FTSE Russell website.
  • June 10 and 17: An updated preliminary list of constituents is posted.
  • June 24: Russell Reconstitution is final after the close of the markets.

The Reconstitution Process: Segmenting, Banding and Breakpoints

As measured by total market capitalization, the 3,000 largest U.S. companies are ranked to become Russell 3000 Index constituents. Subsequently, each companies’ percentage weight within the index helps guide whether it becomes a constituent within the Russell 1000 or the Russell 2000. 

A 5% band separates the Russell 1000 and Russell 2000 indices. Constituents within the band are evaluated relative to the current year’s market-cap breakpoint and allocated between large-cap or small-cap. In 2021, the breakpoint was $5.2 billion. 

Market Capitalization of FTSE Russell U.S. Indices

Source: FTSE Russell

Market Impact

It’s reasonable for investors to anticipate a certain level of market impact coming from FTSE Russell’s annual reconstitution. Especially considering the magnitude of rebalancing multiple indices tracking over $10.6 trillion in assets often leads to the largest trading day of the year. 

Several indicators frequently used by investors to forecast short-term levels of bullish or bearish sentiment come from options. For example, tracking volume on Russell 2000 Index options puts and calls using a put/call ratio can signal levels of market sentiment. Historically, the put/call ratio on index options tends to be skewed as investors can efficiently and cost-effectively hedge using index put options. Since 2015, the average put/call ratio on Russell 2000 Index (RUT) options during the Russell Reconstitution period was 1.71, which was slightly lower than the average of 1.84, indicating minimal change in market sentiment during that time.

Russell 2000 Index Options Put/Call Averages Annual vs. Russell Reconstitution

Sources: Bloomberg & Cboe Global Markets

Implied volatility levels on options are another commonly used indicator to gauge short-term bullish or bearish market sentiment. In particular, the Russell 2000 Index implied volatility as measured by Cboe’s Russell 2000 Volatility Index (RVXSM) tracks the expected 30-day volatility of the Russell 2000 Index based on a series of RUT options pricing.  

Since 2015, RVX is generally lower during Russell Reconstitution (May – June) compared to the annual RVX average. The comparable RVX averages indicate that market participants don’t typically expect a significant change in market pricing during Russell Reconstitution, with the exceptions of 2019 and 2020, as highlighted in the chart below.

RVX Index Averages May-June (Russell Reconstitution) vs. Annual

Source: Bloomberg & Cboe Global Markets

Volatility Risk Premium (VRP)

As a small-cap benchmark, the Russell 2000 Index reflects higher risks associated with small-cap companies and generally carries a higher implied volatility relative to its large-cap counterpart. 

RUT’s elevated implied volatility translates to a higher volatility risk premium (VRP) between the implied volatility as measured by the RVX Index minus RUT’s 30-Day Historical Volatility (HVT). The average difference between the RVX Index and the 30-Day Historical Volatility over the past seven years has been approximately 3.65%. 

The higher volatility risk premium provides investors with potential opportunities to harvest volatility risk premiums used to enhance risk-adjusted returns on portfolios benchmarked to the Russell indices or generate income using well-defined option-writing strategies.

Russell 2000 Index Volatility Risk Premium RVX Index - 30 Day Historical Volatility

Sources: Bloomberg & Cboe Global Markets

As an investment tool, listed options on the Russell 2000 Index allow investors to target risk or returns for a specific time period through various option writing strategies. When considering RUT option writing strategies, it’s worth noting that over 50% of RUT option volume is within RUT Weeklys options, which has expirations on Mondays, Wednesdays and Fridays, as well as at the end of each month and quarter.

Further Reading

Follow the links below for more information on option-writing strategies using Russell 2000 Index options and to learn more about the Cboe-exclusive cash-settled options on Russell Indices.



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