State the term dispersion trading

Question

State the term dispersion trading?

Answer 1

Dispersion trading is a strategy including the selling of options on an index against buying a basket of options upon individual stocks. This strategy is a play upon the behaviour of correlations throughout normal markets and throughout large market moves. When the individual assets returns are extensively dispersed then there may be little movement into the index, however a large movement in the individual assets. It would result in a large payoff on the individual asset options other than little to payback upon the short index option.