This study provides an empirical analysis back-testing the implementation of a dispersion trading strategy to verify its profitability. Dispersion trading is an arbitrage-like technique based on the exploitation of the overpricing of index options, especially index puts, relative to individual stock options. The reasons behind this phenomenon have been traced in literature to the correlation risk premium hypothesis (i.e., the hedge of correlations drifts during market crises) and the market inefficiency hypothesis. This study is aimed at evaluating whether dispersion trading can be implemented with success, with a focus on the Standard & Poor’s 100 options. The risk adjusted return of the strategy used in this empirical analysis has beaten a buy-and-hold alternative on the S&P 100 index, providing a significant over-performance and a low correlation with the stock market. The findings, therefore, provide an evidence of inefficiency in the US options market and the presence of a form of “free lunch” available to traders focusing on options mispricing.

Dispersion trading: an empirical analysis on the S&P 100 options

Ferrari, Pierpaolo;Abate, Guido
2019

Abstract

This study provides an empirical analysis back-testing the implementation of a dispersion trading strategy to verify its profitability. Dispersion trading is an arbitrage-like technique based on the exploitation of the overpricing of index options, especially index puts, relative to individual stock options. The reasons behind this phenomenon have been traced in literature to the correlation risk premium hypothesis (i.e., the hedge of correlations drifts during market crises) and the market inefficiency hypothesis. This study is aimed at evaluating whether dispersion trading can be implemented with success, with a focus on the Standard & Poor’s 100 options. The risk adjusted return of the strategy used in this empirical analysis has beaten a buy-and-hold alternative on the S&P 100 index, providing a significant over-performance and a low correlation with the stock market. The findings, therefore, provide an evidence of inefficiency in the US options market and the presence of a form of “free lunch” available to traders focusing on options mispricing.
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Utilizza questo identificativo per citare o creare un link a questo documento: http://hdl.handle.net/11379/515055
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