Illustrates an example of dispersion trading

Question

Illustrates an example of dispersion trading?

Answer 1

You have bought straddles upon constituents of the SP500 index, and you have sold a straddle at the index itself. On many days you don’t make much of a profit /loss on such position, gains/losses upon the equities balance losses/gains upon the index. However, one day half of your equities increase dramatically, and one half falls, along with there being little results move into the index. On such day you make money on the equity options by the gammas, and also make money on the short index option due to time decay. It was a day on that the individual stocks were nicely dispersed.