Dispersion Trading with Single-Stock and Index Options
Summary
Dispersion trading seeks to capture the difference between index and single-stock option volatility risk premia. A basic position sells index options and buys options on constituent stocks. Because the trade is exposed to correlation, it tends to benefit when individual stocks move less in lockstep and can suffer sharply when correlations rise during market stress. The document also connects differences in option premia to disagreement among analysts about company earnings.
The described S&P 100 approach ranks stocks monthly by an earnings-forecast disagreement measure, buys puts on the highest-disagreement stocks, and sells index puts with specified Black–Scholes delta ranges. The cited research relates belief disagreement and business-cycle conditions to index and single-stock volatility premia; it also summarizes studies of correlation premia and alternative constituent-selection methods. One cited backtest reports returns and Sharpe ratios, but those figures belong to that study’s particular selection framework and sample. The page explicitly warns that dispersion trading is not a bear-market hedge and can incur large losses in crises; results depend on implementation, correlations, and model assumptions.
Key ideas
- Dispersion trades combine short index options with long options on individual constituents to express a view on relative volatility premia.
- The strategy’s returns are closely tied to correlation, with rising correlations creating losses during stress.
- The example ranks S&P 100 firms monthly by analyst earnings-forecast disagreement before selecting single-stock puts.
- Research links disagreement and business-cycle conditions to differences between index and individual-stock option premia.
- Reported backtest results apply to a specific stock-selection method and do not remove crisis risk.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.