Dispersion Trading and the Implied Correlation
A classic dispersion trade involves selling options on an index while buying options on the individual stocks that make up that index. This structure exploits a structural gap: an index’s implied volatility tends to be lower than the average implied volatility of its components. The reason is diversification—individual idiosyncratic risks cancel out at the index level.
Because index volatility rises when stock-level correlations rise, selling index options is effectively a way of selling correlation. Traders who implement dispersion are implicitly assuming that future realized correlation will not rise substantially.
The flows associated with dispersion trades create persistent pressures in options markets:
- Selling index options increases supply and pushes index implied volatility lower. Dealers who buy these options become long vega, meaning they lose money if volatility falls. To manage that exposure, they lower the implied volatility level at which they are willing to buy, reinforcing downward pressure.
- Buying single-name options increases demand and pushes individual stock implied volatilities higher. Dealers who sell these options become short vega, so they raise the implied volatility they charge to compensate for this risk.
The combined effect is to widen the implied correlation spread. While macro forces ultimately determine realized volatility and co-movement, dispersion flows can meaningfully distort market-implied measures, as evidenced by the Implied Correlations Index showing historically low implied correlations of the S&P 500 Index and its top 50 components in the accompanying chart. 
NVIDIA: Concentrated Revenues and Low Market Correlation
According to NVIDIA’s most recent annual report, its top four customers represent 44% of total revenue. Although the company does not fully disclose the breakdown, it is reasonable to assume that its largest customers include some combination of Tesla, Microsoft, Meta, Amazon and Google—all key participants in the artificial intelligence (AI) and data center buildout.
Yet despite their shared economic exposures, participation in the same industry boom and dominance within a top-heavy US equity index, NVIDIA’s daily stock-price correlations remain surprisingly low.
This is unusual: as highlighted nearby, companies that share customers, supply chains, capital expenditure cycles and end-demand trends should display tightly linked risk-factor behavior. The divergence between their fundamentals and their market-implied correlations raises questions about the sustainability of these low price correlations.
As with any strategy that gains popularity, dispersion trading becomes more expensive and fragile as it scales. More importantly, if correlations were to spike, the overall market becomes more vulnerable due to its heavy concentration in a few mega-cap names.
Despite appearing uncorrelated in daily price movements, these mega-cap tech companies remain fundamentally highly correlated. By suppressing index volatility and mechanically depressing implied correlations, dispersion trading may be masking the true level of correlation in the average investor’s portfolio. The mathematically implied diversification may be illusory, and investors could be far more correlated to a single macro risk than market-implied measures suggest.
Mega-Cap Tech 40 Day Stock Price Correlations
Important Disclosures & Definitions
Cboe 3-Month Implied Correlation Index: the index measures correlation market expectations by quantifying the spread between the S&P 500 Index's implied volatility and the average single-stock basket component implied volatility.
Implied Correlation Index: a financial benchmark that provides instantaneous market estimates of expected correlation using implied volatilities of the S&P 500 Index and top 50 component options. The index is calculated using Cboe Hanweck constant maturity delta relative implied volatilities.
S&P 500 Index: widely regarded as the best single gauge of large-cap US equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
Vega: a measurement of an option’s sensitivity to changes in the volatility of the underlying asset.
One may not invest directly in an index.
AAI001037 11/25/2026
