Dispersion Trading

Is there a way to do this model-free?

 

You can call it whatever you want.

 

I was thinking about this earlier. I have done some dispersion trading but not with all components. Cboe has an index ICJ that calculates the correlation between stocks in the S&P. But whats really amazing to think about is that correlation is bound by 0 and 1 (can not have - correlation as a group). On Febraury 5th, ICJ was trading at 70. Putting on a dispersion trade at that time gave you a much better risk reward than selling vol (not bounded). It is also important to know how the index vol is calculated for more intuition

 

When I have stocks and bonds in my portfolio I am "implicity" short volatility (I bet on stability). If I add DOTM puts on the index I am "explicity" long volatility (I bet on a change - or hedge) but the payoff of the latter is non-linear. Premium to buy those options is generated by the bonds.

Something similar to this:


In my opening post the idea was to sell cash secured puts in place of buying bonds.

 

Right nicholas taleb buys bonds and uses the income to buy call options. Look into Chris Coles work aswell (Artemis capital). stocks + puts = calls. So no need to buy the stocks just bonds and calls.

Selling cash secured puts is not the same as buying bonds. For example if you sold cash secured puts in 2008 you would have lost a ton of money while the bonds continued to pay out

 

what do you mean by not bounded?
seems like 2 different trade..

 

When vol increases so does correlation. But vix can go as high as it wants to. Correlation can only go to 1. Yes 2 different trades but they are very correlated

 

That's assuming a 1:1 ratio. How about a 1:20?

 

@TheBigShort Did you have any success with dispersion/correlation trades or are those trades a thing of the past? Seems like now would be a good time to put on a correlation trade, with such low volatility which usually jumps in the fall.