With the sell off on Friday, the Russell 2000 was down 1.29% while the Russell 1000 lost 1.51% last week. Small cap stocks underperformed large caps in 2014 and many have expected this to carry over into 2015. However, so far the Russell 2000 has held its own and is up 1.06% for the year which is basically in line with the performance of the Russell 1000.
In the volatility space the CBOE Russell 2000 Volatility Index was higher gaining just over 7%. RVX is often considered a measure of small cap or domestic equity market risk. As the Russell 2000 is comprised of small cap stocks that are often more volatile that large cap stocks RVX is consistently higher than the CBOE Volatility Index which represents large cap risk and is considered more of a global equity risk measure. While RVX was up only 7%, VIX rose about 14% last week. This is typical during weeks of broad based sell offs like last week. The chart below shows the ratio of RVX divided by VIX on a daily basis from the beginning of 2014 through this past Friday. This ratio finished the week at 1.17.
Note the high level of the ratio throughout most of 2014. Small cap stocks underperformed large caps for most of 2014 and this underperformance resulted in RVX being elevated relative to VIX. Note for most of 2015 RVX the ratio has remained at lower levels which is taken by many market observers as an indication of less relative risk for small cap stocks relative to large caps.
Last week at the Trader’s Expo event in New York I was asked about increased put activity in index options. Specifically if this should be taken as a bearish indicator for the overall equity market. It is difficult to take increased volume as an indication of market sentiment as put volume may actually be bullish and call volume could result from a bearish outlook. The block trades I have seen recently in RUT puts actually is based on a bullish outlook or neutral to bullish. On Wednesday, with RUT at 1229.47 there was a large seller of RUT Mar 1160 Puts at 2.43 who also purchased the same number of RUT Mar 1150 Puts at 1.88 resulting in a net credit of 0.55. The payoff for this trade at expiration, along with where RUT was on Wednesday when this trade was executed is highlighted on the payoff diagram below.
As long as RUT is above 1160 at settlement for Russell 2000 Index options on March 20th this trade results in a gain equal to the credit of 0.55. That means as long as the Russell 2000 does not lose more than 5% (again based on Wednesday’s price) then the trade is a winner. Of course a big drop would result in a loss of 9.45. The point here is not necessarily about the specific trade, just that put volume isn’t necessarily an indication of increased concern about the underlying market. For that I think the better place to look is to implied volatility which for the Russell 2000 is RVX.