Small-Cap Stocks Recover From Loss to Advance Most in Two Weeks

May 09, 2014 4:18 pm ET

May 9 (Bloomberg) -- Shares of smaller U.S. companies posted the biggest increase in two weeks, rebounding after the Russell 2000 Index earlier slipped to within four points of a correction.

Gains in companies from NPS Pharmaceuticals Inc. to Black Box Corp. pushed the small-cap benchmark gauge up 0.9 percent to 1,107.22 at 4 p.m. in New York. The index slipped as much as 0.5 percent in the first hour of trading to 1,091.50, extending its loss since March 4 to 9.7 percent. Reaching 1,087.98 would have completed the 10 percent drop commonly defined as a correction.

Small-caps and Internet shares have been the biggest losers in the market retreat that began two months ago as investors fled last year’s best-performing equities. At the start of the day, the Russell 2000 traded at 24.3 times estimated earnings, compared with 15.9 for the S&P 500, the data show.

“The big question in the market right now is about the overextension of small-caps,” Michael Purves, chief global strategist at Weeden & Co. in Greenwich, Connecticut, said in a May 6 phone interview. The jump in options prices “reflects the thought that the selloff will continue.”

The Russell 2000 Index is still down more than 8 percent from the March 4 record amid concern that prices have outrun earnings. Options costs tied to the equity gauge, which increase as expectations for volatility rise, are at the highest level since February 2007 compared with contracts on the Standard & Poor’s 500 Index.

Hedge funds and other large speculators are betting $2.3 billion that the Russell 2000 will fall, according to data from the Commodity Futures Trading Commission on Bloomberg. That’s near the highest since July 2012. The value reached $2.8 billion last month, the most versus average levels since 2004, data compiled by Bank of America Corp. showed.

Options Cost

Options, used by investors as a tool to protect the value of their stock holdings, have seen their cost increase amid speculation of further declines. The Chicago Board Options Russell 2000 Volatility Index rose 22 percent this year to 21.38 yesterday. A similar measure for the S&P 500 has fallen 2.1 percent to 13.43.

Puts on an exchange-traded fund linked to the small-cap index make up eight of the 10 options with the highest ownership, data compiled by Bloomberg show. There are more than two bearish options outstanding for each call.

“People were just very heavily positioned in small-cap growth names going into the year,” Evan Erlanson, who helps oversee $50 million as chief investment officer at Seres Asset Management in Hong Kong, said by phone today. “Then there is the question of valuation. A lot of small caps have become valued at quite a premium to the overall market.”

--With assistance from Alexis Xydias in London, Adam Haigh in Sydney and Callie Bost in New York.