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Hedge funds have been buying up dispersion trades across several indices this week, driven by confidence on the back of stronger economic data in the U.S. and monetary measures in Europe. Dispersion trading, also known as selling correlation, has been dead in recent months, even as correlation levels on equity indices hit all-time highs.
The market shut down after some funds piled into what appeared to be attractive levels for the sale of correlation several months ago, but they subsequently lost money as correlation stayed flat.
The primary underlying in the trading are the S&P 500 and the Swiss Market Index and their constituents. An example of a dispersion trade is when a firm sells volatility on an index, such as the S&P 500, and buys volatility on a group of constituents from that same index. This is a position to play the view the...