178 Frequently Asked Questions In Quantitative Finance
Why might dispersion trading be successful?
- Dynamics of markets are more complex than can be
captured by the simplistic concept of correlation.
- Index options might be expensive because of large
demand, therefore good to sell.
- You can choose to buy options on equities that are
predisposed to a high degree of dispersion. For
example, focus on stocks which move dramatically in
different directions during times of stress. This may
be because they are in different sectors, or because
they compete with one another, or because there
may be merger possibilities.
- Not all of the index constituents need to be bought.
You can choose to buy the cheaper equity options in
terms of volatility.
Why might dispersion trading be unsuccessful?
- It is too detailed a strategy to cope with large
numbers of contracts with bid-offer spreads.
- You should delta hedge the positions which could be
costly.
- You must be careful of downside during market
crashes.
References and Further Reading
Grace, D & Van der Klink, R 2005 Dispersion Trading Project.
Technical Report,Ecole Polytechnique F ́ ed ́erale de Lausanne ́
