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.