SPX futures are up 7 points to 2086.75 on hints of a pickup in global manufacturing data. Expectations of a rate hike by the Fed will hinge on the nonfarm-payrolls report due out on Friday. The spot VIX finished up a point yesterday to 16.13. This morning the VIX futures are lower across the board given positive equity tone.
Three-month S&P 500 Index implied volatility (14.9) is roughly a point under its 5-year average. The same cannot be said for the Russell 2000 with 3M IV a whole 3.85 points below its 5-year average. Relative to the S&P 500, the Russell 2000 3M IV is trading very cheap historically (5-year graph below). It’s been typical to see the spread narrow during times of a stronger economy and expand during times of economic or market stress. This makes sense in that the Russell 2000 has names that are less mature, with high growth rates, and are more susceptible to economic conditions. The present 3M IV spread differential (Russell – S&P) is 2.85 vol points. The 5-year average is 5.6 and the 10-year average is 6.3. That differential is in the bottom 4% of readings for both 5- and 10-years.
You may also note in the graph that the spread can really spike during times of market panics. The spread jumped over 10 vol points in late 2011, mid-2010, and during the financial crisis. And this is only in a relative sense. As a standalone vol play it may make even more sense. Given the possibility of tightening, a slowdown in the economy, and the seemingly constant threat of terrorist attacks, it makes sense to load up on cheap Russell vol. Russell 2000 3M IV (17.7) is in the bottom quartile of 5-year readings at present and is actually trading below 3M realized volatility (18.9%). As a reminder of what the Russell 3M IV can do, look back to 2011 where it reached 48%… over 30 vol points from present levels.