Mostly done the other way around, in the direction of a persistent risk premium (usually attributed to institutional hedging in indices and covered call writing in the single names). Google "dispersion trade." It's a correlation play. A lot of posts on it here previously on ET, use the search function.
How asset price affects your alpha
- Thread starter TheBigShort
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http://www.nuclearphynance.com/User Files/2/Dispersion - A guide for the clueless 1.1.pdf
Here's a paper that was written by a reputable NP member
Here's a paper that was written by a reputable NP member
Thank you. Clearly something that is not suitable for a small retail trader!
I've been investigating buying relatively cheap AtM vol in the index, and cheap OtM positions on a basket of shares at reversals, and selling expensive AtM (or slightly OtM) options further out. Managing risk for the portfolio quickly becomes complex. FDAXHunter confirms that.
No doubt! I took a stab at this on a much simpler scale (relative value trading SPX vs NDX Or SPX vs AAPL). It's all fun and games when both assets are near their strikes, once they start moving around the PnL's don't look so good anymore. I did a IBB/QQQ relative value trade, IBB drifted way beyond the strike and I ended up with like 2.5x the theta on my QQQ position relative to IBB (I am not to sure what to do in these spots just yet). It's also very capital intensive.
I agree. I took stab at OIH, XLF with their components. It is also time consuming along with capital intensive for one man show. While it produces source of return which is not correlated to market, I abandoned it because of the amount of time that needs to work your order for components. Some times that basis risk itself is bigger than the expected profits.
I believe dispersion today is just a risk premium trade. There is not edge in trading it, like there is no edge in trading iron condors other than the risk premium.
There are papers that have shown that the return on dispersion strategies essentially went to zero in the early 2000s when electronic trading made options more accessible and valuations more transparent.
I’ve never known anyone to make money trading clean dispersion in the 18 years I have traded vol (me included) with the exception of one year (2005 and that was because of MRK and PFE).
There are papers that have shown that the return on dispersion strategies essentially went to zero in the early 2000s when electronic trading made options more accessible and valuations more transparent.
I’ve never known anyone to make money trading clean dispersion in the 18 years I have traded vol (me included) with the exception of one year (2005 and that was because of MRK and PFE).