Och-Ziff Capital Management has just made a big trade — a $12bn dispersion one.
It’s kind of a nifty way to bet on an end to QEased suppression of market volatility, at a time when traditional safe haven assets like gold and government bonds could be considered over-priced. The trade is this: almost $12bn of options, including $8.8bn of options on companies within the Standard & Poor’s 100 Index. The S&P options include both (bearish) puts and (bullish) calls, in almost equal measure. (Alright, if you want to be really specific, Och-Ziff reported $5.4bn of puts and $3.4bn of call options – making the position slightly more bearish.)
Och-Ziff might be following an options strategy known as a “dispersion trade” that has become increasingly popular this year, said Jared Woodard, principal at Condor Options, a New York-based trading and research firm that focuses on market-neutral strategies.
Dispersion trades are a way of betting on an end to the historically high market correlation that began during 2008, when shares of companies in various industries all rose and fell together, frustrating money managers who earned their keep by researching and picking individual companies.
In a dispersion trade, managers sell put and call options on an index such as the S&P 100 during market declines, when demand is heavy among investors who want to protect themselves from losses. They use the rich premiums received for the index options to buy put and call options on some or all of the stocks comprising the index.
The missing link to the dispersion trade theory is whether Och-Ziff sold index options, which hasn’t been disclosed. But as Woodard notes, buying options on 93 out of 100 stocks in the S&P 100 doesn’t really look like stockpicking.
It’s a relatively cheap way to short correlation — and go long volatility, but it’s not without risk. Especially timing.
Here’s a bit more from Condor Options’ Woodard:
I’m not actually a fan of betting against high correlation here, even several years after the financial crisis. Intuitively, an environment in which individual index components move more independently is an environment in which the details of those individual companies are the primary drivers of stock prices, and broad macroeconomic factors are less important. As far as I can tell, we’re still living in a risk-on/risk-off world. You know how, when guests and anchors on financial television networks run out of things to say, they sometimes resort to, “Well, it’s a stock-picker’s market”? Besides being perennially vapid, as far as I can tell that claim is still mostly false.
Related links:
Beware sticky summer: no time for the beach – Gillian Tett, FT
Hedge funds rediscover attraction of dispersion trade - Hedge Funds Review
The calm before the (volatility) storm – FT Alphaville