Sunday, August 29, 2010

CBOE Implied Correlation Index

I had never heard of the CBOE Implied Correlation Index before. It looks like its been out for a little over a year. It's something I plan to keep an eye on and use in my basket of inputs to try and gage market conditions.

Cut and Paste from CBOE below

The CBOE S&P 500® Implied Correlation Index

The CBOE S&P 500 Implied Correlation Index is the first widely disseminated, market-based estimate of the average correlation of the stocks that comprise the S&P 500 Index (SPX). Using SPX options prices, together with the prices of options on the 50 largest stocks in the S&P 500 Index, the CBOE S&P 500 Implied Correlation Index offers insight into the relative cost of SPX options compared to the price of options on individual stocks that comprise the S&P 500.
  • CBOE began disseminating daily values for the CBOE S&P 500 Implied Correlation Index in July 2009, with historical values back to 2007.
  • CBOE calculates and disseminates two indexes tied to two different maturities, usually one year and two years out. The index values are published every 15 seconds throughout the trading day.
  • Both are measures of the expected average correlation of price returns of S&P 500 Index components, implied through SPX option prices and prices of single-stock options on the 50 largest components of the SPX.
  • Ticker symbols JCJ, KCJ and ICJ:
    • JCJ - calculated through Nov 2010 expiration, using Dec 2010 SPX options and Jan 2011 equity LEAPS options
    • KCJ - calculated through Nov 2011 expiration, using Dec 2011 SPX options and Jan 2012 equity LEAPS options
    • ICJ - will be added in Nov 2010 using Dec 2012 SPX options and Jan 2013 equity LEAPS
The CBOE S&P 500 Implied Correlation Index 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.
"One of the perceived benefits of owning a portfolio of stocks is diversification related to the correlation between stocks. While less correlation between stocks in a portfolio typically leads to greater diversification, the correlation between stocks is constantly changing, and in times of market stress the correlation increases as stock prices tend to move together. As a result, the diversification benefits of a portfolio of stocks may be less than initially anticipated."
--- Joe Levin, CBOE Vice President of Research and Product Development

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