Absolutely, my friend. It's is my belief that most dispersion players are not locking-vols profitably. The bid/offer vol offers greater variance than the likely return on the strategy.
What exactly do you mean by âlocking Volsâ ? Are you implying they could be profitable if they did it right ? Not sure what you mean here; do you mean the Index Vol vs Component Vol has a moderate amount of variance which could be exploited ? Or are you talking about the bid/offer spread of the components ? Any views / tips / pointers with regards to running a reverse dispersion trade. Lots of questions - thanks again.
Quote from Profitaker: What exactly do you mean by âlocking Volsâ ? Are you implying they could be profitable if they did it right ? Miscues in correlation and the lack of marks to the actual bid/offer vols being traded in index/comp. Not sure what you mean here; do you mean the Index Vol vs Component Vol has a moderate amount of variance which could be exploited ? Or are you talking about the bid/offer spread of the components ? bid/offer spread on component vols. Any views / tips / pointers with regards to running a reverse dispersion trade? +dispersion: Cover opposing[delta position] outlier-component straddles and buy the neutral straddle to replace/match correlation. Your long ABC comp straddle is trading 80d with your XYZ comp straddle trading -80d; cover opposing deltas and go long neutral straddles in both. The +80/-80d straddles were initally neutral-delta. You're simply rolling into the current neutral straddle to bank the +disp, component gains. It's not maintaining a pure-corr, but it's analogous to scalping long gamma. Trade narrow index markets like the dow. -dispersion: Trade into law of large numbers; as many index components as you're able to muster; avoid narrow index markets. With -dispersion you can be sloppy on execution and still make bank provided you're diversified in buying the replication[box] volatility.
Well, I see that you've been waiting patiently. I didn't want to give you a one-liner, nor a dissertation[not that I am up to that task]. I didn't see your questions until this morning.
Risk Just a quick one if I may.... Why is there so little written material on this strategy ? is it the domain of hedge funds only ? Closly guarded secret etc ?
I really don't know. Initially, I think there were large $$ being made with an arbitrage with a low barrier to entry. It made sense not to crap where you eat. Now I simply think it's played-out and fully-vetted... it's not esoteric enough to write journal articles. It would be akin to writing a paper about conversions. It's really the domain of Susq and GS(HTC), and has been since inception. I am sure they're locking a 99.7xx correlation and making a few hundred basis over tbill.
What is more important when selecting components for the PARTIAL replication ? 1. Component's IV/HV ratio or 2. Component's correl with Index According to Egar , currently MO has IV/HV of 1.17 (meaning that potential stock's move will NOT cover the premium) , but it's also has a very low (16.5) correl with Index ( good odds to move in deferent that Index's direction ). Using the same logic , looks like the best candidate to exclude this month is AIG (IV/HV is 1.22 and corell=82) Thoughts?