BANKNIFTY Dispersion Trading with Implied Volatility and Delta Hedging

Summary

This project tests an options dispersion strategy that compares BANKNIFTY implied volatility with the weight-adjusted implied volatility of its constituent stocks. The author estimates average implied volatility from first out-of-the-money calls and puts, forms a ratio called dirty correlation, and calculates a rolling Z-score. When that score crosses an entry threshold, the strategy takes opposite strangle positions in the index and its constituents, then hedges portfolio delta with futures at regular intervals. Positions are closed when the score returns within an exit threshold.

The reported test uses 15-minute observations from January 2017, with a 30-observation lookback and a one-month sample. The author describes positive expected P&L as evidence of potential, while explicitly cautioning that the period is too short to support a firm conclusion. Suggested next steps include testing longer histories and varying sampling frequency, hedge rules, and entry and exit thresholds. Transaction costs and robustness beyond the stated sample are not established in the text.

Key ideas

• The strategy trades differences between index implied volatility and constituent-stock implied volatility weighted by index membership.
• A rolling Z-score of the volatility ratio defines entry and exit conditions.
• The positions pair index strangles with opposing constituent strangles and periodic futures delta hedges.
• The reported backtest covers only one month of intraday data, so its positive expectation is preliminary.
• The author identifies longer samples and parameter testing as important extensions.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.