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Key Points
Investors can go short correlation through building a portfolio of short index
and long stock volatility a successful carry trade over the last 10 years
Volswap-to-Volswap dispersion has replaced Var-to-Var after the 2008
financial crisis as a lower-risk alternative to trading dispersion
Due to particular trade dynamics, you would ask for larger expected
correlation P&L before embarking on vol-to-vol dispersion the recent push
in implied correlations may provide the right incentive
Other factors that impact potential dispersion P&L: neutral to positive market
performance and extended valuation multiples, and a higher index volatility
skew
S&P dispersion ranks high on all factors; SX5E has a more mixed outlook
80%
Realised 6M
70%
60%
50%
40%
30%
20%
10%
0%
2005
2007
2009
2011
2013
2015
Implied 6M
80%
Realised 6M
70%
60%
50%
40%
30%
20%
10%
0%
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
S&P (1997-2015)
SX5E (2009-2015)
3M
6M
1Y
3M
6M
1Y
9.5%
11.6%
12.2%
5.1%
6.5%
8.4%
10.2%
13.2%
13.2%
5.7%
7.7%
8.3%
-29.9% -29.6% -24.1% -38.9% -20.7% -11.0%
-10.4% -10.2%
-8.0% -15.2% -14.1%
-4.9%
81%
82%
78%
66%
73%
80%
60%
SPX
50%
SX5E
40%
30%
20%
10%
0%
1997
-10%
1999
2001
2003
2005
2007
2009
2011
2013
-20%
-30%
-40%
Post 2008: short index vol swaps vs long single stock vol swaps, after the
2008 financials collapse showed the inherent risk for market makers in
being short single stock variance
Sector correlation trades: index vs sectors with vol or variance swaps;
typically when sector rotations drive inter-sector correlations lower, and
intra-sector correlations higher
All approaches lead to imperfect exposure to correlation
2 2
& = 2 2
=1
2 , =
2
2 , = 2 =
=1
=1
& =
=1
10
& =
=1
11
Dispersion P&L: between 1 vega (SX5E) and 1.4 vega (S&P) median
P&L, for circa 70% positive trades
Less favorable P&L to Loss ratio than pure correlation P&L due to cross
exposure with volatility, but equivalent to short index variance or volatility
12
1500
1000
500
0
2002
-500
2004
2006
2008
2010
2012
2014
-1000
-1500
-2000
SPX
SX5E
-2500
13
Vol-to-Vol vs Var-to-Var
Due to a larger, positive sensitivity to the volatility skew, variance swaps
allowed to sell index volatility for slightly more than single stocks, than
when using vol swaps
Actual, achieved correlation levels were larger with variance swaps
(assuming 0.5 vol and 1.5 vol bid ask spreads)
Avg S&P 6M
SX5E 6M Implied
Implied Correl
Correl (2009(1997-2015)
2015)
With Vol Swaps
43.4%
58.8%
With Var Swaps
46.8%
63.5%
Dispersion P&L using vol swaps are therefore typically lower, but risks are
also 1/3rd lower (see next slide)
This is an academic discussion given that var-to-var does not trade
anymore
14
2000
1000
0
-3,000
-2,000
-1,000
1,000
2,000
-1000
SX5E (2005-2015)
-2000
SPX (2005-2015)
-3000
-4000
15
Theta-Weighted vs Vega-Weighted
An alternative to the theta-weighted scheme consists of using similar vega
on the long and the short (H=1 in the equation on slide 10)
& =
+ (1
=1
=1
( ) = & +
=1
Being long single stock vol helps cushioning losses in the event of a
simultaneous correlation and vol shock (typical in an Equity sell-off): max
loss of 13x vega only versus 20 in the theta weighted scheme
This is at the cost of a less interesting carry: median P&L of 0.5x vega
only versus 1.4 in the theta weighted scheme
16
2000
2000
1500
1000
500
0
-3,000
-2,000
-1,000
-500
-1000
-1500
1,000
SX5E (2005-2015)
SPX (2005-2015)
2,000
2500
1500
1000
500
0
-4,000
-2,000
0
-500
-1000
2,000
4,000
6,000
SX5E (2005-2015)
SPX (2005-2015)
17
4
3.5
Vol = 10%
Vol = 20%
2.5
Vol = 30%
2
1.5
1
0.5
0
0%
20%
40%
60%
80%
100%
4.5
60%
55%
50%
Effective Correl
45%
40%
10%
Mid Correl
20%
30%
40%
18
110
100
Weight of S&P
10%
in Basket
Mean
Median
Stdev
Min
Percentile
100%
118
171
225
-619
-257
90%
113
158
216
-559
-250
80%
107
146
207
-498
-251
70%
101
138
200
-467
-245
60%
95
128
194
-439
-238
50%
90
121
189
-418
-230
40%
84
111
186
-396
-218
30%
78
101
184
-375
-200
20%
72
93
184
-367
-202
10%
67
84
186
-386
-202
0%
61
78
189
-405
-214
90
80
All
70
S&P
SX5E
60
0.5*S&P + 0.5*SX5E
50
170
180
190
200
210
220
230
21
Outperf of
Optimised Basket
vs Full Dispers
Outright
Dispersion
0%
68
78
188
-408
-210
67%
0
0
0
0
0
100%
100%
10%
76
87
181
-437
-190
70%
8
14
45
-297
-28
73%
97%
20%
83
93
186
-483
-183
71%
15
23
56
-291
-44
71%
96%
30%
91
103
187
-512
-175
74%
23
29
69
-264
-61
70%
94%
40%
106
114
192
-515
-163
76%
38
37
91
-305
-57
71%
89%
50%
121
124
202
-594
-158
78%
53
47
113
-409
-63
75%
84%
60%
143
134
228
-575
-164
79%
75
59
152
-404
-80
75%
76%
70%
173
147
287
-551
-181
79%
105
65
224
-426
-99
74%
64%
80%
197
150
343
-712
-186
77%
129
66
286
-590
-116
72%
56%
22
Outperf of
Optimised Basket
vs Full Dispers
Outright
Dispersion
0%
30
132
334
-1376
-384
71%
0
0
0
-4
0
100%
100%
10%
20
140
357
-1489
-358
69%
-9
4
71
-418
-104
55%
98%
20%
18
139
364
-1543
-342
68%
-12
3
85
-557
-124
53%
98%
30%
19
140
364
-1542
-333
68%
-11
1
95
-592
-120
51%
97%
40%
23
143
368
-1509
-313
68%
-7
0
105
-656
-123
50%
96%
50%
31
142
371
-1574
-307
68%
2
8
119
-701
-138
55%
95%
60%
41
142
377
-1563
-273
68%
12
18
134
-825
-131
59%
94%
70%
54
137
390
-1696
-264
71%
24
24
165
-836
-139
58%
91%
80%
72
138
416
-1851
-236
74%
42
26
221
-867
-139
59%
85%
23
25
Equity valuations:
Realised correlation is larger during times of acute crisis when valuation metrics are low
Correlation decreases markedly when equity markets are expensive and investors have
to turn to stock picking in order to generate performance
SX5E
Correlation with 6M
Correlation with 6M
Factor
Realised Correlation t-Stat Realised Correlation t-Stat
12M Fwd Price-to-Earnings
-55.3% -44.9
-5.6% -0.1
S&P Coincident Performance
-32.7% -23.4
-46.9% -0.5
Agg. $ Consideration of M&A Deals Announced
-7.2%
-4.9
16.5%
0.2
26
Realised Correlation
60%
50%
40%
30%
SPX (1997-2015)
20%
SX5E (2009-2015)
10%
0%
10
15
20
25
30
Realised Correlation
60%
50%
40%
30%
SPX (1997-2015)
20%
SX5E (2009-2015)
10%
0%
-60%
-40%
-20%
0%
20%
40%
60%
28
80%
SX5E (2009-2015)
70%
60%
Realised Correlation
50%
40%
30%
20%
10%
0%
29
SX5E
Correlation to 6M
Correlation to 6M
"Correlation P&L" t-Stat "Correlation P&L" t-Stat
53.1% 42.4
60.6% 28.4
69.3% 65.1
42.9% 17.7
39.7% 29.3
13.4%
5.0
19.2% 12.9
24.2%
0.3
6.3%
4.3
35.0% 13.9
-8.7% -5.9
-31.5% -12.4
9.7%
6.6
21.7%
8.2
3.2%
2.2
-23.9%
-9.2
16.4% 11.2
2.2%
0.8
-6.2% -4.2
-4.4%
-1.6
-4.8% -3.2
-1.5%
-0.6
-21.1% -14.6
21.4%
8.2
30
30%
20%
10%
0%
-10%
0%
20%
40%
-20%
60%
80%
SX5E (2009-2015)
-30%
SPX (1997-2015)
-40%
100%
1500
1000
500
0
0%
20%
40%
60%
80%
100%
-500
SX5E (2005-2015)
-1000
SPX (2005-2015)
-1500
31
1500
50%
40%
30%
20%
10%
0%
-60%
-40%
-20%
-10%
-20%
-30%
-40%
0%
20%
40%
SX5E (2009-2015)
SPX (1997-2015)
60%
60%
1000
500
0
-60%
-40%
-20%
0%
20%
40%
60%
-500
-1000
SX5E (2005-2015)
SPX (2005-2015)
-1500
32
50%
40%
30%
20%
10%
0%
-10%
10
15
-20%
20
25
SX5E (2009-2015)
-30%
SPX (1997-2015)
-40%
30
60%
1000
500
0
0
10
15
20
-500
-1000
SX5E (2005-2015)
SPX (2005-2015)
-1500
33
50%
SPX (1997-2015)
40%
SX5E (2009-2015)
30%
Correl P&L
20%
10%
0%
-10% 0%
2%
4%
6%
8%
-20%
-30%
-40%
10%
12%
60%
1000
500
0
0%
2%
4%
6%
8%
10%
12%
-500
-1000
SPX (2005-2015)
SX5E (2005-2015)
-1500
34
500
2%
1%
-1%
-500
2007
2009
2011
2013
-1000
-2%
-1500
-3%
-2000
500
Skew Diff
3%
0%
2005
1000
1000
4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
-500
2012-2015
-1000
2005-2011
-1500
-2000
35
37
90%
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Implied 6M
80%
Realised 6M
70%
Forecast
60%
-500
-1000
-1500
Correlation Level
500
50%
40%
30%
20%
10%
-2000
0%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
38
1200
100%
1000
90%
800
80%
600
70%
400
60%
200
0
2002
-200
-400
-600
-800
2004
2006
2008
2010
2012
2014
Correlation Level
50%
40%
Implied 6M
30%
Realised 6M
20%
Forecast
10%
0%
2009
2011
2013
40
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41