Dispersion trading
OptionsAdvanced
Dispersion trades the gap between index implied volatility and the implied volatility of the index members. A basic version sells index options and buys options on the constituents, looking for realized correlation to land below the correlation implied by the index. It is a correlation position. It loses when stocks start moving together.
Not investment advice. Nothing here is a recommendation to buy or sell anything. Backtests and historical studies are not guarantees, and a rule that worked in one sample can fail in the next. Trading can lose money. Links are for education, not endorsements. Do your own research.
- Rules
- Sell a strip of index options and buy a weighted strip of single-stock options with a documented vega or delta hedge. Rebalance hedges on a schedule. A researched variant tilts the long single-stock options toward names with wider disagreement in analyst forecasts. Keep the gross vega and the correlation exposure inside a limit, and plan the unwind when correlation spikes.
- Where AI fits
- AI can check hedge weights, corporate actions, and whether the single-stock options still match the index members. It can monitor realized correlation against the implied correlation the position assumed. It should not compress this into 'sell the index and buy stocks' without the option quantities.
- Markets
- Index options and options on the liquid members. This is an institutional book. A retail account usually cannot hedge it as specified.
- Timeframes
- Weeks to a month, with daily or intraday hedges.
- Risks
- Correlation jumps in selloffs, which is when the short index option hurts most. Member options are wider and harder to hedge. One takeover or earnings gap in the long strip does not offset an index move. The trade needs margin, borrow, and a desk that can manage a book of hedges.