Inside Volatility Trading: Options and Markets to Be Grateful For

Kevin Davitt
November 16, 2021

Is It Different This Year?

Next week, Americans will celebrate the Thanksgiving holiday. From a big picture standpoint, there are countless reasons to be grateful in 2021. Equity markets in the U.S. are at record levels. COVID numbers are improving domestically and globally. Earnings and employment data has been strong too.

Last year, gathering for the holidays was a concern. This year will likely be different because 68% of Americans over the age of 12 are fully vaccinated. Almost time to grab a plate!

On average, a Thanksgiving meal will pack on between 3,000 – 4,500 calories. We’re able to sample a wide variety of flavors to suit nearly every palate.

The U.S. derivative markets also offer a buffet of alternatives from which to choose. Let’s look at some of those possible choices and where market participants have been gorging lately.

Big Run for Small Caps

Back in September we highlighted some of the unique attributes for the small-cap Russell 2000 Index. The key differences compared to the large-cap S&P 500 Index include: constituent valuation, increased domestic exposure, less concentrated makeup, and a history of higher realized/implied volatility.

Over the past two years, the Russell 2000 Index and S&P 500 Index are both up ~50%. If we look at the past 52-weeks, the small-caps have significantly outperformed. The Russell 2000 Index broke above the multi-month range and established new all-time highs during the first week of November (2021). Keep in mind, U.S. equities sold off ahead of the 2020 elections. Since early November of last year, the trend has been higher with shallow pullbacks along the way. So, the 52-week time frame is a favorable one.

Russell 2000 Index & S&P 500 Index

Source: Cboe LiveVol Pro

Before we get into the “meat and potatoes” (or turkey and stuffing as it were), let’s level set on the products we’ll discuss. The Russell 2000 is an index. As such it’s a non-tradeable calculation methodology managed by FTSE Russell. It tracks the performance of ~2000 small cap U.S. companies.

There is a robust derivatives ecosystem that has developed around the Russell Indices. There are Russell 2000 futures, cash settled Index options (both standard - RUT and mini - MRUT contracts), and there are ETF products designed to track the Index as well as options on the ETFs.

Index vs. ETF Exposure

There are some important variations between Index and ETF options. Index options, like RUT and MRUT, cash settle at expiration. In-the-money ETF options (like IWM) physically deliver long/short shares of the underlying. RUT and MRUT options are European styled whereas IWM options are American styled. In other words, IWM options may be exercised/assigned in advance of expiration. And Index options typically benefit from Section 1256 of the IRS tax code, whereas ETF options generally are not extended the same benefit. *Any tax consideration should be discussed with a professional.

Getting Started with Index Options (

One other distinction – RUT options have a large notional value (~240k) compared to IWM options (~24k). Market participants may use a single RUT contract to hedge or gain exposure to ten times the notional value of IWM, while MRUT options have effectively the same notional value as IWM options.

Back to the markets and booming option volumes. The appetite for index call options has been insistent.


Over the last 180 trading days (~9 months) the realized volatility for the RUT Index is 21.4%. The same metric for the S&P 500 is 12.2%. 

RUT (and IWM) volume has been very strong for three months. On November 1 and 3, 2021, IWM call volume set a new five year high. During the same time frame on the index side, RUT call options saw the highest volume day since January of 2018.

During the first full week of November (2021), RUT options ADV (average daily volume) was 160% of the 3-month average. Even more unusual, RUT calls traded more actively than puts. The average put to call ratio in RUT and IWM is 1.55: 1.0. One of the primary uses for Index options is to hedge specific portfolio risks. Individuals and institutions typically have long exposure to equities. As such, Index put options tend to trade more actively than calls.

Let’s look at the macro backdrop and what happened to the small caps in the month following previous surges in call volume.

Macro Backdrop of Small Caps

Source: Cboe LiveVol Pro

History as a Guide

On December 22 2017, The Tax Cut and Jobs Act was signed into law. This Trump Administration effort was the most significant shift in U.S. tax codes in decades, and it was well received by the markets. Between Dec (2017) and late January (2018), the Russell 2000 Index added 8.5%. The S&P 500 Index jumped about 7%. U.S. equities made local highs during the last week of January and then fell roughly 10% in very short order. The Cboe Volatility Index® (VIX® Index) moved from below 11 to slightly over 50 intraday in six sessions.

In a vacuum, the RUT call buyers from mid-Jan 2018 were ostensibly “wrong” from a purely directional standpoint. However, if those positions were delta hedged, the long volatility (vega) exposure could be beneficial following the sharp selloff a few weeks later.

During the first weeks of January (2021) the U.S. equity markets, and particularly small caps ramped higher. Vaccine rollouts were beginning, and stimulus legislation was gaining traction in Congress. Later in the month, the “meme-stock short squeeze” reached its zenith.

Between January 5 and February 10, 2021, the Russell 2000 Index rallied 20%! It was a historic run for the small-cap index and from a directional exposure standpoint, the call buyers from early January were arguably in a strong position. Furthermore, January was unusual in the sense that implied volatility measures (RVX) for RUT options increased as the Index advanced. Typically, there’s an inverse correlation between implied volatility (IV) and index levels, but that was not the case in early 2021. There’s a similar positive relationship of late.

This serves as a reminder that correlations measure relationships over distinct periods of time. The interplay between index levels and the implied volatility levels for their options are typically negative, but not always!

Standard Deviations

The square root of variance gives you a standard deviation. That output is based on historical data so it’s static. By contrast, option prices are dynamic, forward looking estimates that embed assumptions about future deviations for the underlying. For example, an option with an implied volatility of 25 is priced based on an annualized standard deviation expectation of +/-25%.

The visual below comes from Christopher Jacobson via Susquehanna Investment Group. He mapped the daily volatility adjusted moves in the Russell 2000 Index for the past four months.

Daily Volatility of Russell 2000 Index

Source: Susquehanna Investment Group/@ChristopherJacobson

Let’s apply the “Rule of 16” in this situation. Volatility is proportionate to the square root of time, and implied volatility is expressed as an annualized number. There are ~256 trading days in a year and the square root of 256 is 16. By dividing RUT’s implied volatility by 16, we can calculate the daily one standard deviation range for the index.

One month at the money (ATM) RUT options are currently trading on a 20% IV. Let’s calculate our daily one standard deviation range and convert to price terms.

  •  0.20/16 = 0.0125 (daily 1 standard deviations of 1.25%)
  • RUT Index = 2430*0.0125 = +/-30.375 handles daily

In late October and early November, the Russell 2000 Index was regularly realizing volatility (daily swings) more than the expected one-standard deviation range. If that continues, a delta hedged basket of long options with an IV of 20% would likely be profitable. If the market fails to realize >1 standard deviation moves, then we would expect decay to exceed our delta/gamma hedging P&L.

Weaving in our Thanksgiving narrative, you could think of decay like the amount of activity required to burn the calories embedded in each meal. At times we burn more than we consume. Other times we’re not active enough and the decay adds up.


Zooming out, forward volatility measures typically tend to decline from their peak in October through the end of the calendar year. This visual shows the average VIX Index level by month since its inception.

Average VIX Index Since Inception

Source: Cboe Global Markets

The historical tendency for the VIX Index to typically increase between the end of July and October is clear. We can see a less pronounced propensity for the VIX Index to typically decline between the end of October and January. As mentioned, generally there is a negative (longer term) correlation between the VIX Index and S&P 500 Index levels.

Between 1980 and 2021 (YTD) on average the S&P 500 Index has increased by 1.48% in November and another 1.11% in December.

S&P 500 Index Performance

Source: Cboe Global Markets

The relationship between the VIX Index and the S&P 500 Index as well as RVX and Russell 2000 Index, generally has been positive in early November. That’s unusual. Both indices have been making new highs early in the month. However, the VIX Index and RVX continue to inch higher. Between November 3rd and 8th, the VIX Index moved from 15.10 to 17.22 on a closing basis.

The RVX is mostly moving higher since October 21, 2021, when it closed at 20.34. By November 8, 2021, the 30-day forward expected volatility for the Russell 2000 climbed to 24.15. Over the same time frame, the Russell gained 6.7% (reference RUT 2443).

What are the implications of higher IV for option prices, all else constant? Let me show you using Cboe’s Options Calculator.

In the first example, we calculate the Greeks for an ATM RUT call option with a month until expiration assuming a 20.34% IV.

The option is theoretically worth $57.12 and there’s $3.69 in daily decay (expressed in cents).

What if we calculate the price and decay for the same option and assume 24.15% vol?

Now our ATM option has a theoretical value of $67.54 and $4.34 in daily decay.

The option is 18% more expensive and the decay is 17.6% more with a month until expiration.

What’s the standard deviation assumption embedded in the option at each vol level?

  • .2034/16 = 0.0127 or 1.27% daily = 2430*0.0127 = 30.89 points
  • .2415/16 = 0.0151 or 1.51% daily = 2430*0.0151 = 36.68 points

In other words, the buyer of the ATM call option on a 24.15 IV needs larger daily moves (greater activity) to offset the theoretical decay (calories). Higher vol is somewhat like adding gravy to everything.

At Odds with Rates Vol

Despite equity volatility sneaking higher lately, the VIX Index remains much closer to the low end of the two-year range that encompasses the COVID selloff. If we assume a 17 VIX Index, then volatility is only ~18% above the VIX Index level from February 19, 2020 (old highs). The 52-week lows for VIX Index were 15.01.

Harley Bassman helped create the MOVE Index in the early 1990’s which is a benchmark for interest rate volatility. The MOVE Index is arguably far less sanguine than its equity vol counterpart.

MOVE uses 1-month implied volatility levels for over the counter treasury options across the U.S. rate curve (2Y, 5Y, 10Y, & 30Y). Bassman has said: “one can think of the MOVE as ‘the VIX Index for bonds’ “. In November of last year, the MOVE Index measured just below 40. By comparison, on November 8, 2021 the MOVE Index closed just below 71. That’s ~77% above the 52-week lows.

MOVE Index for November 8, 2021

Source: Google Finance

Macro Risk Advisors put it similarly in a recent research piece. In “price” terms (2019 – present), the MOVE Index is in the 90th percentile range whereas the VIX Index is in the 12th percentile. In other words, looking back to 2019, the VIX Index has only been lower 11% of the time. The MOVE Index has been below the current level 89% of the time. The writeup goes on to point out that “markets incorporate information at different speeds." For example, the S&P 500 Index was making new highs late in 2007 despite credit markets signaling elevated concern.


With six weeks remaining in calendar year 2021, there’s so much to be grateful for. Equity markets continue to advance. Option volumes are likely to establish another full year record. The labor market is improving with unemployment declining to 4.6%. Interest rates remain low from a historical standpoint.

The path ahead is arguably far less uncertain than it was a year ago. Significant uncertainty remains, but that’s always the case. Options afford us the ability to shape the potential distribution of outcomes until maturity, which is another thing to be grateful for.

“Showing gratitude is one of the simplest yet most powerful things humans can do for each other.”

-Randy Pausch: Author, Professor of Computer Science at Carnegie Mellon

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