How to do it? Anybody cares to elaborate on it? I am thinking of doing some backtest and post some results here... I have tried backtesting a few vol-selling option spread strategies, the pnl curves look ugly and the Sharpe Ratio is only 0.3 ... for the past 4 years...
I am pretty sure you are increasenow with a larger vocabulary. Next I would like to see a thread where you two go back and forth asking questions and no answers. Bang.
Here you go: http://www.nuclearphynance.com/User Files/2/Dispersion - A guide for the clueless 1.1.pdf
Thanks a lot! Lets lets think from the sell-side trader's perspective: suppose you are the sell-side index trader, and you can see the index flow, and flow of individual components, you also see flow of the index options as well as the individual components' options... (is that how an index trading desk work in a bank?) how would you make the dispersion trade in your favor? (i.e. not an average joe's dispersion trade) I ask this question because I want o understand the business (profit) model of the big sharks a bit better... Thank you!
(1) No. Index desk and single stock desks are separate desks. (2) Number of ways, but none of them via perfect replication. Frequently it's just passive flow on exotics desks, since most of single stock business is short vol while index exotics is generally geared toward index products. Sometimes there is a separate dispersion desk that does judicious dispersion trading. I could go into more detail but only if there is a good reason you doing this (interview prep or homework is not a good reason).
According to the paper Martinghoul posted the consensus seems to be the trade is pretty fairly priced. The edge doesn't come from the trade itself but being able to provide a market for large orders with edge (as in the example given). "So, if you have the likes of Allianz and AIG asking you for markets in single stock options and they happen to be for about five times the average volume in those things, you can either tell them to get lost or you can take down the paper for a bit of edge and do the (more liquid) index side against it, effectively establishing the beginning of a dispersion position. (either long or short)." Did you read the paper? There's some great info there, imo (even if it's true about dispersion having lost its edge). For example: "SEX WITH SHEEP Itâs good. Give it a try one day."