By Chuck Mikolajczak
NEW YORK (Reuters) - Friday could offer an especially wild ride on Wall Street as traders react to the vote on British membership in the European Union and adjust their portfolios to the annual reconstitution of the widely followed Russell stock indexes.
The annual FTSE Russell index adjustment, in which stocks are added to and subtracted from the Russell 2000 <.RUT> small company and Russell 1000 <.RUI> large company indexes, typically produces the year's highest volumes.
This year, that effect will be exacerbated because active investors who might have otherwise jumped out in front of the Russell announcement may have been waiting for the so-called "Brexit" vote to conclude.
"Long indexers are not going to want to pre-trade their positions" lest share prices change dramatically on Friday and they end up far from their benchmark indexes, said Chad Dale, director of index and ETF research at ITG in Toronto.
The Russell announcement is expected after the market close on Friday. There will be heavier-than-usual after-market trading then, as index manages race to adjust their portfolios so they can track their index benchmarks starting on Monday morning.
Options traders are betting on outsized volatility. The CBOE Volatility Index <.VIX>, the favored gauge of investor anxiety over U.S. stocks, ended on Wednesday at 21.17, its highest close in four months. It pulled back on Thursday, down 15.3 pct at 17.94, on track for its biggest one-day drop since Jan. 22. All of the expected volume will not necessarily result in correspondingly extreme moves in share prices, traders say. But they concede that adding the Brexit vote results to the stew does increase the odds of a sharp market move in one direction or the other.
"If 'Remain' wins, then probably the (U.S. stock) market will move higher," said Stephen Massocca, chief investment officer at Wedbush Equity Management LLC in San Francisco.
"If 'Leave' wins, it will be a mirror image of that - there will be an immediate sell-off that could be rather severe, but once cooler heads prevail, the market could move back higher," he said.
Options on the S&P 500 index <.SPX> are pricing a 1.5 percent move for the index, in either direction, by Friday.
Financial stocks will also be active and could move on Friday if there are surprises late on Thursday when the Federal Reserve releases results of its annual economic stress tests of U.S. banks.
Shares of companies added to the Russell indexes would likely rise, while that were dropped would fall.
Both the New York Stock Exchange <ICE.N> and Nasdaq <NDAQ.O> have expressed confidence their systems will be able to handle the reconstitution trades. But they have also put contingency plans in place to handle any unexpected interruptions, as they have in recent years.
FTSE Russell expects the day-ending volatility and can deal with any anomalies, said Tom Goodwin, a company senior research analyst. "We are really not that concerned."
(Additional reporting by Trevor Hunnicutt, Rodrigo Campos, Caroline Valetkevitch and Saqib Ahmed; Editing by Linda Stern and Dan Grebler)