Dispersion trade faces thin margins of safety
The host argued that the popular dispersion trade is currently being priced with very little margin of safety due to extremely low implied correlation levels.
The argument
The dispersion trade involves buying single-stock options and selling index options. The host noted that while the trade is carrying well due to near-zero realized correlation, the entry price is highly unfavorable because the VIX EQ index trades at a premium of over 20 vols relative to the VIX index.
The thesis, stress-tested
✓ What validates it
- ✓A sharp contraction in the spread between the VIX EQ index and the VIX index
- ✓An increase in realized index correlation during down days
▸ Risks discussed
- ▸A sudden, highly correlated market selloff (e.g., a tariff tantrum or macro shock) that causes index volatility to spike
Hear it yourself
"So I was pleased to find the VIX EQ index, the S and P constituent vol index, I e, one month weighted average single stock vol for members of the S and P. They apply the VIX methodology to a series of single stocks weighted based on the S and P weights and out pops a number."
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