Empirical Aspects of Dispersion Trading in U.S. Equity Markets
Marco Avellaneda, November 2002
Petit Dejeuner De la Finance

Dispersion trading (DT) consists of a strategy where one simultaneously sells index options and buys options on the index components or, vice-versa, buys index options and sells options on the underlying stocks. The fundamental theme associated with DT is ``correlation trading''. This presentation gives stylized facts about DT in U.S. equity markets and some of the main indicators of correlation that can be used in dispersion trading. We derive some statistical properties of these indicators and outline a somewhat crude but effective approach to price-discovery using the method of steepest descent (RISK Magazine, October 2002). The talk also discusses hedging and risk-management considerations for the resulting option portfolios.