Stock<>Index Option Arbitrage?

Quote from atticus:
Dispersion
You're best to tinker with OTM calls rather than eat the index skew on short dispersion (in puts).
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I think the real edge is in vol or var swap dispersion... if you got enough capital to play, of course.
 
Quote from sondermark:

implied volatility of the components was on (weighted) average 17.55% higher than the index.... seems like an arbitrage opportunity
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This. is. not. an. arb.

As a rule of thumb, the formula:

index_vol = sqrt(correlation) * weighted_avergage_component_vol

isn't a bad approximiation.

So index vol at 83% of component vol implies a correlation of 0.69 (.83 squared). Your "arb" is just a bet that realized correlation will be lower than 0.69.

Acutal formula is:

sqrt( summation(i)[v(i)^2*w(i)^2] +2*sumsum(i,j>i)[v(i)*v(j)*w(i)*w(j)*p(i,j)])

where v is vol, w is weight, and p is rho or correlation.

Or in matrix form: sqrt(W'QW)

where Q is the covar matrix and W is a vector of weights.


Did you read the paper posted earlier in the thread?
 
Hi Guys,

Thank you for all your help the last days.

I have read the paper several times and after working a bit with it finally understand dispersion theory. For some reason I was really slow to grasp this.

Again, I do really appreciate your help!

Kind regards,
Steffan
 
Quote from sle:

Really? Are you going to "crunch the numbers"?
My impression was that you specialize in picking bottoms...
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Don't mock ForexForex. He puts the ELITE in EliteTrader.

Without him this site is just Trader.
 
Hi, I am trying to understand the concept of dispersion.

Quote from Atticus: "You're best to tinker with OTM calls rather than eat the index skew on short dispersion (in puts)."

Can Atticus or somebody clarify/explain the above quote. Does that mean that it is better to be short index call instead of long index put on short dispersion?

Thanks in advance
 
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