Market Neutral Spread

D

dohdat

Hi there,
I'm wondering if I sell 3 bull put spread and 3 bear put spread on 6 different companies, is this considered a market neutral strategy? Thank you.
 
A long-held*, little-tested** truism is that 70% of an individual stock's movement stems from the overall market, and only 30% is attributable to that individual equity. But yesterday's enormous divergence between the NASDAQ and the DOW showed that ultimately, knowing those individual stock identities is necessary, to see whether they are correlated positively, negatively, or not-at-all.

While your thought of 'market neutral' works on the back of the napkin, in actual use, no one can say. If you're serious about the strategy, run a 6x6 comparison, so you can best sort who to put in the bullish camp, and whom to put in the bearish. Then you'd have a basis for 'market neutral' expectation.

* by some...
** by most...
:D
 
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tommcginnis said:
A long-held, little-tested truism is that 70% of an individual stock's movement stems from the overall market, and only 30% is attributable to that individual equity.
More...
While tongue in cheek, the general idea is that eventually idiosyncratic movement adds to less than the movement of the market, even if it composes a big portion of the daily variance. It's like those Russian cars - every part is moving separately but the whole thing gets to the same destination, more or less.

I think most people either over or under-estimate the contribution of the overall market on the behavior of a particular stock. If you own a biotech or a recent IPOed start-up, it's pure idiosyncratic risk. If you own small-cap stocks, most of you risk is idiosyncratic (which, btw, makes statistical arbitrage so much easier for retail-sized players). On the other hand, if you own a stock from the top 50 in S&P 500, the amount of uncorrelated movement is going to be pretty small.
 
If the stocks correlate, the entire position would be closer to market neutral than not. If not correlated, not so much.

For example, if your 3 bear spredas were in the O&G sector and the other 3 were financials, it's quite possible that both threesomes could make money (or both lose) as one sector rises while the other drops. OTOH, if these were all S&P stocks, it's more likely that they would correlate somewhat and one threesome would gain and the other might lose.

And then there's individual stock news which has nothing to do with the other 5 stocks.
 
yeah after the last few days. i was too bullish on tech companies. got burnt hard. maybe being market neutral would help.
 
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