Each year the Russell 1000, 2000 and 3000 Indices, widely considered as barometers of the U.S. economy, are reweighted to ensure they remain representative of changes in markets that took place over the past year. This year, the newly reconstituted indices will take effect after the market closes on Friday, 28 June 2024, and begin trading on Monday, 1 July 2024.

The annual Reconstitution is one of the most significant drivers of short-term shifts in demand for U.S. equities, often leading to sizable price movements and volatility in individual company names or industry sectors. The final day of the rebalance is typically one of the highest trading volume days of the year in the U.S. equity markets. At the June 2023 Reconstitution, $72.7 billion and $61.7 billion in U.S. stocks traded in the closing moments of Friday trading on the New York Stock Exchange (NYSE) and Nasdaq exchanges, respectively.

Approximately $11 trillion of equity market exposure is benchmarked to the Russell U.S. Indices, with countless ETFs and mutual funds mirroring the composition of the Index suite.

Rather than having to execute trades across 2000 or more individual names in the exact quantity for each individual stock to match their holdings to the changes in the index, an investor can simply trade CME Group E-mini and Micro E-mini Russell 2000 futures in lieu of stocks. Short holders have the added complication of locating a source to borrow the relevant shares of a company that remains within the index, often in less liquid names. The benefit of holding a futures position is that the investor does not have to trade the Reconstitution themselves; the futures contract will track the index and there will be no operational error or tracking error incurred by trying to replicate the Reconstitution.

An efficient way to manage the Reconstitution and rebalance risk is by using CME Group E-mini Russell 2000 futures (Globex code: RTY). We see clients switching to futures ahead of the recon date for two main reasons. Firstly, to more efficiently manage the rebalance process from an operational perspective, and secondly, for the capital efficiencies of futures. Provisions for exchange-for-physical transactions, block trading and Basis Trade at Index Close transacting ensure that multiple avenues are open to contract users for position entry and exit.

The Basis Trade at Index Close (BTIC) mechanism allows Equity Index futures contracts, such as RTY, to be traded intraday at a spread to the day’s closing index price. By buying RTY contracts via a BTIC transaction and selling a comparably sized cash portfolio on the close, for instance, the investor can seamlessly replace their stock position which increases operational efficiency and reduces costs.

Over 5,215 RTY BTIC contracts trade a day. This functionality has grown in popularity and use. In 2022, BTIC ADV was around 3.8K. In 2023, BTIC ADV grew 31% to over 5,000 daily trades. In addition to those clients tracking the index, BTIC functionality is particularly useful for clients who are trading the additions and deletions and wish to have a beta position against the main index. The minimum block size for BTIC is 40 contracts.

A holder may replace their physical exposure with E-mini Russell 2000 futures by using the Exchange for Physical (EFP) transaction, which allows an investor to exchange ETFs, ETNs or baskets of the underlying index constituent stocks for an equivalently scaled number of offsetting RTY contracts, and then to carry the resultant futures position through the index rebalancing.

In this transaction, one party is the buyer of the futures and seller of physical shares, ETFs/ETNs or OTC positions, and the other is the seller of the futures and buyer of the physical shares, ETFs/ETNs or OTC positions.

Following index Reconstitution, the investor may either execute a second EFP trade to move the index exposure back into a portfolio of shares or may continue to hold the index exposure in the futures contract to benefit from better capital efficiency.

Another way to manage the rebalance is using the roll to transition a futures position from one quarterly futures contract month to another contract further in the future. This means offsetting the current position and establishing a new position in a forward month. Traders do this when they do not want to give up their market exposure when the contract expires.

The Russell futures contracts expire on the third Friday of March, June, September and December, with the next expiration set on June 21, 2024, and participants can roll their futures positions at any time.

• There are two ways to roll a contract forward:
• To leg in, which means selling the June contract, then buying a September contract in two separate transactions
• Initiate a spread, or position roll, which will simultaneously execute a closing order of the nearby (June) contract and the establish a new position in the next contract month (September)

Unlike legging in, with a spread, there is no time gap in between the two orders. That is important because a time gap can result in slippage, the potential loss from market moves between the closing and opening orders. Using the roll to move positions forward in a single transaction minimizes the chance of slippage.

The Russell 2000 complex has a tremendous growth story since its return to CME Group in 2017. Among RTY’s market characteristics are deep liquidity and substantial open interest – two key features for anyone concurrently trading futures and cash index exposures.

So far this year through to end of May 2024, E-mini Russell 2000 futures (Globex code: RTY) have averaged 225K contracts per day ($22.5 billion notional) and the Micro E-mini Russell 2000 futures (Globex code: M2K) have averaged 90K contracts per day in 2024 ($880 million notional).

Open interest averages are close to 575,000 contracts. This growth enables market participants clear transparent pricing around the clock and a liquid order book in which to manage positions. Relative to adjacent Russell 2000 markets, RTY futures have traded three times more than all the most liquid ETFs combined that track the Russell 2000 combined.

First launched in 1984 and now on the 40th anniversary, the Russell U.S. Indices continue to reflect the ever-changing U.S. equity market, and the annual Reconstitution process is critical to maintaining accurate representation.

Representing the U.S. small-cap market segment, the total market capitalization of the Russell 2000 Index increased 7.4% from $2.7 trillion as of last year’s Reconstitution to $2.9 trillion.¹

With banding applied, the largest company in the Russell 2000 Index is Applied Industrial Tech ($7.1 billion market cap), an 18.3% increase from last year’s largest company in the index. The smallest company in the index is Richardson Electronics ($150.4 million market cap), a 5.7% decrease compared to the smallest company in the index in 2023.

Index membership and rankings are determined using total market capitalizations as of Reconstitution rank date, April 30, 2024.

Source: FTSE Russell. Data as of April 30, 2024

During this highly anticipated market event, the breakpoints between large-, mid-, and small-cap are redefined to ensure market changes that have occurred in the preceding year are captured. 

Health care is a recurring theme in this year’s rebalance. This year, 243 companies are joining the Russell 2000 Index – 30 dropping down from the Russell 1000 Index, 116 shifting up from the Russell Microcap Index, 86 companies joining from outside of the Russell U.S. Indices universe, with the highest number of companies from health care (26 companies) and financials (21 companies) 11 IPO’d companies are being added, seven companies are from the health care sector.

Additionally, 171 companies are departing the Russell 2000 Index: 28 companies are moving to the Russell 1000 Index, 94 are moving to the Russell Microcap Index and another 49 companies are leaving the Russell U.S. Indices universe.

The largest industry in the Russell 2000 remains Industrials at 19.1%, followed by health care at 16.7% (the largest increase, from 14.7%) and financials at 16.0%. Technology decreased from 13.7% to 11.3%, the largest decrease.

Year-to-year changes in the breakpoint between the Russell 1000 and the Russell 2000, i.e., the market capitalization that demarcates the boundary between large-cap and small-cap sectors, make a useful gauge of secular growth in market valuations. 

The breakpoint between the large-cap Russell 1000 and small-cap Russell 2000 indices increased 9.5% from $4.2 billion in 2023 to $4.6 billion.

The lower bound of the Russell 2000 is likewise indicative. At this year’s Reconstitution, the threshold market capitalization for a new index member was around $150.4 million; in 2023 it was $159.5 million, 6% higher.

Changes in the capitalization breakpoint separating the large-cap Russell 1000 from the small-cap Russell 2000 indices are highly correlated with real GDP growth rates, indicating that the indices accurately capture economic growth patterns.

U.S. small-cap stocks are suffering their worst run of performance relative to large companies in more than 20 years, highlighting the extent to which investors have favored mega-cap technology stocks and the AI revolution, while smaller companies have been weighed down by high interest rates.

The Russell 2000 index has risen 4% since the beginning of 2021; aside from a brief period of outperformance in 2020 during the early stages of the coronavirus pandemic, small-cap stocks have lagged the S&P 500 and Nasdaq-100, both with around a 50% gain over the same period. The unusually wide gap in performance shakes up a long-term historical norm in which fast-growing small-caps stocks like the Russell 2000 historically outperformed large-cap stocks like the Russell 1000, the Nasdaq-100 and the S&P 500 over the long-term.

Small-cap stocks with relatively weak balance sheets, lower margins and modest pricing power have been especially hurt by high inflation and a steep rise in borrowing. Smaller companies typically rely more heavily on lines of credit to grow, and higher interest payments to service these debts affect their bottom line. Close to 40% of the debt on Russell 2000 is on a short-term floating rate compared with about 9% for S&P 500 firms. Some of the larger firms are cash rich and are making a decent return just by collecting interest on T-Bills or other short-term securities. 

Spread trading with futures is a technique that can be used to take advantage of price discrepancies and involves simultaneously going long and short futures contracts with the hopes that the profits on one leg of the spread are greater than the losses on the other leg of the spread.

For example, a trader with an opinion on small-cap stock performance compared to large-cap stock performance could use futures on the Russell 2000 and S&P 500 indices, to initiate an inter-market spread trade to represent their opinion by entering an intermarket spread strategy combining purchase of RTY futures and sale of an equivalently sized number of CME Group E-mini S&P 500 Index futures (Globex code: ES) contracts. At this writing, the CME Group Clearing margin spread credit is 80% for a position scaled to 2 RTY long (short) versus 1 ES short (long).

RTY futures likewise can furnish users with a means to utilize intra-market price discrepancies. A trader can enter a calendar spread, for example, by buying September RTY contracts and selling an equivalent exposure in December RTY contracts, if an opportune price discrepancy emerges between the two delivery months.

Although on a short-term basis, small-caps are underperforming large-cap stocks, the reverse is true over a longer period, and illustrates the value of having a diversified portfolio incorporating small-cap stocks, or small-cap indices, like the Russell 2000. It is possible to find star stocks by holding the Russell 2000 over the long term.

About half the Russell 2000 Index is split among three sectors: industrials, financials, and health care. Both the industrial and financial sectors are cyclical industries, closely following the business cycle. While these industries may have experienced slow growth in recent periods, the inevitable economic recovery and eventual interest rate cuts will undoubtedly have a positive impact on industrials and financials, and, in turn, the Russell 2000 Index itself. Several health care companies joined the Russell 2000 index this year.

Steady U.S. growth compared to Europe has meant more international interest in the Russell indices, as volatility has increased outside the U.S. with relatively weak growth estimates for 2024. Overseas investors see the Russell 1000 index as a pure play on the large-cap space while they see the Russell 2000 as a distinct expression on the U.S. economy especially as they have much less multinational exposure as large caps.

The Exchange’s listings include companion short-dated weekly options, monthly, and quarterly options on RTY futures, enabling a wide array of option spread strategies and Russell 2000 Index volatility plays.

Russell 2000 options see an average daily volume of over 15,600 contracts, up 86% (from an ADV of 8,370 contracts) year on year. E-mini Russell 2000 options had a record volume day of 39,834 on December 14, 2023. Weekly options have represented the majority of options volume in the Russell 2000 suite, with 80% of all options average daily volume coming from the weekly varieties. 

Trading E-mini Russell 2000 futures is an excellent choice for investors who want to capitalize on the potential of the often-overlooked small-cap stocks. It also helps those who prefer to diversify from the more expensive technology and large-cap stocks and get better exposure to high-growth potential innovative companies in the fields of finance, energy, and health care.

Many traders consider it a suitable way to capitalize on expected market movements in the underlying index. The annual Russell Reconstitution is usually one of the most heavily traded days of the year in the cash equities market, and investors have increasingly been using CME Group E-mini Russell 2000 futures to manage their risk or take advantage of possible opportunities in stock additions and deletions.

Through the choice of the E-mini and the Micro E-mini contracts brings a much wider horizon to investors. CME Group also offers futures products based on the Russell 2000 Growth Index and the Russell 2000 Value Index, potentially useful for many purposes, including cash equitization solutions and tactical asset allocation. 

1. All figures in this section are taken from FTSE Russell’s paper entitled: 2024 Russell U.S. Indices Reconstitution: summary of preliminary changes.