Signal for Dispersion Trading — CBOE S&P 500 Implied Correlation Index (JCJ) Has Fallen 27.8%

In recent years Investors often have asked if stocks have high correlations and move in lockstep with each other.

The CBOE S&P 500® Implied Correlation Index (JCJ-E Jan. 2014) fell from 87.1 on Dec. 14, 2011, to 62.87 on Jan. 8, 2013, a drop of 27.8%

A Jan. 9th Bloomberg News story by Cecile Vannucci, Alexis Xydias and Nikolaj Gammeltoft noted that:

“ … The Chicago Board Options Exchange S&P 500 Implied Correlation Index has fallen 12 percent to 62.87 since reaching a four-month high in December. The gauge, which uses options to measure expectations about whether Standard & Poor’s 500 Index companies will move in lockstep, reached 59.76 on Jan. 2, its lowest level since November 2010. Alcoa Inc., the first company in the Dow Jones Industrial Average to report results, started the fourth-quarter earnings season yesterday. Improvement in the world’s largest economy will reduce the market’s sensitivity to government reports, allowing investors to focus on individual companies, Anthony Benichou of Louis Capital Markets said. … “

The CBOE S&P 500 Implied Correlation Indexes measure changes in the relative premium between index options and single-stock options. The CBOE S&P 500 Implied Correlation Indexes may be used to provide trading signals for a strategy known as volatility dispersion (or correlation) trading. For example, a long volatility dispersion trade is characterized by selling at-the-money index option straddles and purchasing at-the-money straddles in options on index components. One interpretation of this strategy is that when implied correlation is high, index option premiums are rich relative to single-stock options. Therefore, it may be profitable to sell the rich index options and buy the relatively inexpensive equity options. (The language in this paragraph is excerpted from, which has much more information on this topic.)

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