Dispersion Trading

Trade Dynamics, P&L Drivers And Our

Outlook for S&P and SX5E Dispersion

Credit Suisse Equity Derivatives Strategy, May 2015

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

A Guide To Dispersion Trading

How To Build A Correlation Exposure

Whats Implied Correlation?

Implied correlation corresponds to the trade-off between an indexs volatility and
that of its single stock constituents. Although there is a more correct (but more
complex!) formula, for a well diversified index I composed of n stocks with
weights wi and volatility i, correlation is usually approximated as:
2
=
2
=1

Implied correlation is derived from implied volatilities or varswap and volswap

quotes. Realised correlation corresponds to the actual, average level of pairwise
correlation realised in the index over the consecutive period
Equity correlation is typically positive, and its distribution more stable (normally
distributed) than volatility, which exhibits large skewness and kurtosis:
Implied
Implied
Implied
Realised Realised Realised Implied
Realised
S&P Correlation
3M
6M
1Y
3M
6M
1Y
Vol 6M
Vol 6M
Average Since 1996
42.1%
44.7%
46.2%
32.3%
32.4%
32.5%
20.0%
17.7%
Std Dev
11.9%
11.7%
11.7%
12.7%
12.2%
12.1%
6.0%
8.5%
Median
42.2%
45.4%
46.8%
30.6%
30.7%
30.5%
19.2%
15.8%
Min
8.1%
11.7%
14.5%
8.0%
6.3%
6.1%
10.3%
7.2%
Max
81.6%
77.3%
77.5%
75.6%
71.1%
61.9%
55.1%
58.2%
Skewness
0.1
-0.1
-0.1
0.9
0.9
0.6
1.3
2.2
Kurtosis
-0.2
-0.3
-0.4
0.9
0.7
-0.2
3.1
6.5
4

S&P Correlation History

90%
Implied 6M

80%

Realised 6M

70%
60%
50%
40%
30%
20%
10%
0%
2005

2007

2009

2011

2013

2015

SX5E Correlation History

100%
90%

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

Why Go Short Implied Correlation? (1)

Due to supply and demand imbalances, implied correlation tends to be
priced expensively
Index volatility is typically pushed higher by systematic equity hedgers
Single stock volatility is cheapened by systematic stock overwriters
Since 1996, S&P 6M implied correlation has averaged 45% when realised has
averaged only 32%

A theoretically great carry trade:

S&P 6M implied vs consecutive realised correlation has been positive 80% of the time
since 2005 with average P&L of 11 correl points
Worst loss has been 30 correlation points in 2008
Correlation P&L
Average
Median
Max Loss
5% Percentile
% Positive

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%

Why Go Short Implied Correlation? (2)

6M Implied Minus Consecutive 6M
Realised Correl

60%
SPX

50%

SX5E

40%
30%

20%
10%

0%
1997
-10%

1999

2001

2003

2005

2007

2009

2011

2013

-20%
-30%
-40%

Implementing a Correlation Trade

Prior to 2008: short index variance vs long single stock variance, typically
in a theta-weighted basket; correlation swaps

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

Var-to-Var Dispersion: the world before 2008

In a typical, pre-2008 dispersion trade you were:
Short a variance swap on an equity index with strike KI, realised vol I, and notional NI
Long a portfolio of variance swaps on the index constituents, with strikes Ki (0<i<n), realised vols
i (0<i<n) and notionals Ni, with hedge ratio H:

2 2

& = 2 2
=1

Notionals were chosen in order to offer same theta: investors would go

slightly shorter index variance, with:
=

2 , =

2
2 , = 2 =
=1

=1

Pay-off could then be decomposed into a correlation P&L, multiplied by a

scaling factor that would depend on single stocks realised variances, but
leaving investors exposed to dangerous cross exposures

& =
=1

10

Vol-to-Vol Dispersion: A Less Risky Alternative

After 2008, single stock variance swaps were replaced with volatility
swaps with lower embedded tail risk

Vol-to-Vol dispersion trade P&L can still be decomposed between a

correlation exposure and volatility exposure, but:
Correlation component now depends on the square root of correlation, ie non linear exposure
to correlation
Volatility component depends on single stocks realised volatilities, not variance
Overall a less risky P&L than var-to-var (exposure to average vol, not average var, and
concavity of exposure to correlation cushions losses during correlation peaks)

& =

=1

11

Vol-to-Vol: Profitable, But Imperfect Correlation Trade

Strongly, but not perfectly exposed to correlation:
Equation in slide 3 is only an approximation
Typically investors go long only top 50 names in S&P and most liquid names in SX5E vs
short the index (like we do in backtests below)
Single stock volatility scaling factor

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

For 100 Vega

Average
Median
Max Loss
5% Percentile
% Positive
Median P&L / Loss

S&P 500 (2005-2015)

SX5E (2002-2015)
Dispersion Dispersion
Short
Dispersion
Correlation P&L P&L Short
Index
Correlation P&L Dispersion P&L - Short
Short
P&L
Varswap
VolSwap Index Var Vol
P&L
Varswap VolSwap
Index Var Index Vol
11.1%
64
51
231
236
8.0%
217
78
288
206
13.4%
172
143
445
374
8.9%
155
98
457
319
-29.6%
-3478
-1970
-5483
-3486
-27.3%
-469
-555
-4072
-2879
-15.9%
-550
-584
-1532
-1547
-12.8%
-158
-271
-1319
-1291
80%
79%
73%
82%
78%
78%
86%
70%
79%
71%
0.8
0.3
0.2
0.3
0.2
0.7
1.0
0.4
0.3
0.2

12

Vol-to-Vol Dispersion P&L History

P&L of Vol-to-Vol Dispersion (100 Vega)

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

Vol-to-Vol vs Var-to-Var P&L

Var-to-Var Dispersion P&L (100 vega)

2000
1000
0

-3,000

-2,000

-1,000

1,000

2,000

-1000
SX5E (2005-2015)
-2000

SPX (2005-2015)

-3000
-4000

Vol-to-Vol Dispersion P&L (100 vega)

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)

In vol-to-vol dispersion this has the consequence of making the investor

long single stock vol on top of the correlation exposure:

& =

+ (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

Theta-Weighted vs Vega-Weighted (2)

For 100 Vega

Average
Median
Max Loss
5% Percentile
% Positive
Median P&L / Loss

S&P 500 (2005-2015)

SX5E (2002-2015)
Dispersion Dispersion
Short
Dispersion
Dispersion
Correlation P&L - Theta P&L - Vega Short
Index
Correlation P&L - Theta P&L - Vega Short
Short
P&L
Weighted
Weighted
Index Var Vol
P&L
Weighted
Weighted
Index Var Index Vol
11.1%
51
2
231
236
8.0%
78
36
288
206
13.4%
143
46
445
374
8.9%
98
-5
457
319
-29.6%
-1970
-1274
-5483
-3486
-27.3%
-555
-659
-4072
-2879
-15.9%
-584
-366
-1532
-1547
-12.8%
-271
-278
-1319
-1291
80%
73%
59%
82%
78%
78%
70%
49%
79%
71%
0.8
0.2
0.1
0.3
0.2
0.7
0.4
0.0
0.3
0.2

2000

2000
1500
1000

500
0
-3,000

-2,000

-1,000

-500
-1000
-1500

1,000
SX5E (2005-2015)
SPX (2005-2015)

Vol-to-Vol Theta-Flat Dispersion P&L (100 vega)

2,000

Diff Between Vega-Flat and Theta-Flat

Volswap Dispersion P&L (100 vega)

Vol-to-Vol Vega-Flat Dispersion P&L

(100 vega)

2500

1500
1000

500
0
-4,000

-2,000

0
-500
-1000

2,000

4,000

6,000

SX5E (2005-2015)
SPX (2005-2015)

Long Single Stock Vol P&L (100 vega)

17

Vol-to-Vol Disp In A Low Vol, High Correl Environment

Because vol-to-vol is exposed to the square root of correlation, a typical 10 points
difference between implied and realised correlation translates into lower P&L when
correlation baseline level is high. This is magnified in a low vol environment
Additionally trading costs take a larger toll when vol is low: at 20% vol and 60% correl,
typical trading costs result in an effective correlation of 52%
You would typically ask for larger correlation P&L before embarking on vol-to-vol
dispersion trades
65%

4
3.5

Vol = 10%

Vol = 20%

2.5

Vol = 30%

2
1.5

1
0.5
0

0%

20%

40%

Correlation Baseline Level

60%

80%

100%

Effective Correl (ass. 0.3 and 1 vol

pts cost for index and single stocks)

Expected P&L For 10pts Correl Gain

4.5

60%
55%
50%
Effective Correl
45%
40%
10%

Mid Correl

20%

Single Stock Baseline Vol

30%

40%

18

Enhanced Dispersion Trades

Improving the Risk Reward of Dispersion
Exposure

Enhancement # 1: The Benefits of Diversification

With only 40% correlation between the P&L of S&P and SX5E dispersion
trades since 2005, there is ample diversification benefit to be had by
investing in a globally diversified dispersion
A portfolio invested in 50/50 S&P and SX5E dispersion allows the
investor to reach higher average profit than simply S&P with similar risk
130
120

110
100

Average P&L (100 vega)

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

Std Dev of P&L (100 vega)

20

Enhancement #2: Stock Picking

Looming idiosyncratic risks combined with risk aversion, as well as supply
and demand imbalances, may cause some single stock implied volatilities
to trade at a premium
Excluding stocks with expensive implied volatilities does improve P&L for
SX5E dispersion trades
This comes in exchange of higher replication risk
This is not the case for S&P, where profit improvement is marginal
compared to the larger tracking error

21

SX5E Optimised Dispersion

We select stocks based on the difference between implied volatility, and
the average of recent realised and the median realised vol over the last 2
years
Selecting only the 50% best stocks on that metric allows to improve P&L
75% of the time, with average outperformance of 0.5 vega, and 85%
correlation with full dispersion trade

Outperf of
Optimised Basket
vs Full Dispers

Outright
Dispersion

% Stocks Excluded From Long Basket

Average
Median
Stdev
Max Loss
10% Percentile
% Positive
Average
Median
Stdev
Max Loss
10% Percentile
% Positive
Correlation of Optimised With Full Dispers

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

S&P Optimised Dispersion

The same selection as implemented for the SX5E shows no significant
improvement in risk reward
S&P is a more balanced index and superior underlying for dispersion with
little scope for optimisation

Outperf of
Optimised Basket
vs Full Dispers

Outright
Dispersion

% Stocks Excluded From Long Basket (Top 50)

Average
Median
Stdev
Max Loss
10% Percentile
% Positive
Average
Median
Stdev
Max Loss
10% Percentile
% Positive
Correlation of Optimised With Full Dispers

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

Dispersion P&L Drivers

How to Time Your Correlation Exposure

What Makes Up A Successful Dispersion Trade?

Lower realised correlation:
Fundamental factors: equity performance, valuation, M&A activity

Higher implied correlation:

Technical factors: systematic prevalence of index hedgers and stock
overwriters, temporary market correction driving vols higher
Higher stock realised volatility
To turn a correct correlation bet into a significant profit

25

Fundamental Drivers Of Realised Correlation

Equity market performance:
Realised correlation is larger during equity market corrections

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

Little impact of M&A activity: probably because typical dispersion baskets

include mainly extra large caps, which are not natural M&A targets
S&P

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 vs Equity Valuations

The most efficient predictor of realised correlation
PE of 10 = avg 6M realised correl of 60%, PE of 15 = avg correl of
40%, PE of 20 = avg correl of 30%
90%
80%
70%

Realised Correlation

60%

50%
40%
30%

SPX (1997-2015)

20%

SX5E (2009-2015)

10%
0%

10

15

20

25

30

12M Fwd Price-to-Earnings

27

Realised Correlation vs Equity Market Performance

90%
80%
70%

Realised Correlation

60%

50%
40%
30%
SPX (1997-2015)

20%

SX5E (2009-2015)

10%
0%

-60%

-40%

-20%

0%

20%

40%

60%

Coincident Index Performance

28

Realised Correlation vs Global M&A Activity

90%
SPX (1997-2015)

80%

SX5E (2009-2015)

70%
60%

Realised Correlation

50%
40%
30%

20%
10%
0%

50,000 100,000 150,000 200,000 250,000 300,000 350,000

$ Consideration of Deals Announced

29

What Factors To Watch Before Implementing A Trade?

We look at factors which exhibited good correlation with dispersion P&L in
the past factors not fully taken into account in implied correlation prices
Selected Factors:
Valuation multiples, coincident market performance
Absolute implied correlation level, index skew
Prior changes in implied correl (in particular for SX5E)
S&P
Factor
Implied Correl Level
Coincident Underlying Perf
Implied to Realised Correl Spread
Index Vol Skew
Index Vol Level
M&A Activity
Prior Change In Implied Correl (1M)
12M Forward Price-to-Earnings
Prior Change in Underlying
Prior Change in Index Vol
Prior Change in SS Implied Vol (1M)
SS Implied Vol Level

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

Correlation/Dispersion P&L vs Implied Correl Level

Rule of thumb:
Buy 6M dispersion when effective correl level (after transaction costs > 60%)

Implied to realised correlation spread is a less efficient indicator

60%
50%
40%

Correl P&L (100 vega)

30%
20%
10%
0%

-10%

0%

20%

40%

-20%

60%

80%
SX5E (2009-2015)

-30%

SPX (1997-2015)

-40%

Implied Correlation (%)

100%

Vol-to-Vol Dispersion P&L (100 vega)

1500
1000
500

0
0%

20%

40%

60%

80%

100%

-500

SX5E (2005-2015)

-1000

SPX (2005-2015)

-1500

Effective Implied Correlation (in %)

31

Correlation/Dispersion P&L vs Equity Performance

Odds improve in times of strong equity performance:
Typically lower volatility and lower correlation in rising markets
90% probability of achieving >0 P&L if underlying index performance is positive; 70%
probability of >0 P&L for flattish performance (+/- 5%)
SX5E dispersion P&L tends to be less correlated to SX5E performance

1500

50%
40%

Correl P&L (100 vega)

30%
20%
10%
0%
-60%

-40%

-20%

-10%
-20%
-30%
-40%

0%

20%

40%

SX5E (2009-2015)

SPX (1997-2015)

Coincident Equity Performance(%)

60%

Vol-to-Vol Dispersion P&L (100 vega)

60%

1000
500

0
-60%

-40%

-20%

0%

20%

40%

60%

-500
-1000

SX5E (2005-2015)
SPX (2005-2015)

-1500

Coincident Equity Performance (in %)

32

Correlation/Dispersion P&L vs Valuation Ratios

Dispersion P&L is good when valuations are low: typically after a sell off when
risk perceptions and implied correlations are high
Dispersion P&L improves markedly when equity markets are expensive as
investors have to turn to stock picking in order to generate performance
PEs of over 20 were observed only in the late 90s but coincided with profitable
trades (based on correlation P&L)
1500

50%
40%

Correl P&L (100 vega)

30%
20%
10%
0%
-10%

10

15

-20%

20

25

SX5E (2009-2015)

-30%

SPX (1997-2015)

-40%

FWD Price-to-Earnings Ratio

30

Vol-to-Vol Dispersion P&L (100 vega)

60%

1000
500
0
0

10

15

20

-500

-1000

SX5E (2005-2015)
SPX (2005-2015)

-1500

FWD Price-to-Earnings Ratio (in %)

33

Correlation/Dispersion P&L vs Skew

We find circa 25% correlation between index volatility skew and
subsequent correlation P&L
Direct: a higher skew inflates the index vol or variance swap strikes vs ATM volatility
which translates into a higher effective correlation
Indirect: a higher skew could be the sign of stronger demand for equity protection,
lifting the entire index vol surface up versus single stocks
1500

50%

SPX (1997-2015)

40%

SX5E (2009-2015)

30%

Correl P&L

20%
10%
0%
-10% 0%

2%

4%

6%

8%

-20%
-30%
-40%

6M 90/110 Volatility Skew

10%

12%

Vol-to-Vol Dispersion P&L (100 vega)

60%

1000
500
0
0%

2%

4%

6%

8%

10%

12%

-500

-1000

SPX (2005-2015)
SX5E (2005-2015)

-1500

6M 90/110 Volatility Skew

34

S&P/SX5E Dispersion Performance vs Skew Differential

Since 2012 S&P dispersion has systematically performed better than
SX5E dispersion
Although this can be linked to S&P index outperformance (see slide 27),
a likely driver has been the record differential in skew
Over the last few years, a booming structured retail market, and general
disaffection for equity and hedging in Europe, has pushed SX5E skew to
record lows, while S&P skew has rebounded to near all-time highs
P&L Diff

500

2%

1%

-1%

-500
2007

2009

2011

2013

-1000

-2%

-1500

-3%

-2000

500

Diff Between S&P and SX5E

Disersion P&L (100 vega)

Skew Diff

3%

0%
2005

1000

1000

Diff Between S&P and SX5E Dispersion

P&L (100 vega)

S&P/SX5E 6M 90/110 Skew Spread

4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

-500

2012-2015
-1000

2005-2011

-1500
-2000

S&P/SX5E 6M 90/110 Skew

35

Dispersion Trading In 2015

Outlook And Recommendations

Strong Outlook for S&P Dispersion

S&P dispersion trades have had their best 6-months since 2012 with an
estimated profit of circa 4x vega (6M Top 50 dispersion)
Strong correlation P&L (20 correl pts) at lower baseline correl levels than in 2012 (6M
realised correl at 30 to 35pts)
Single stock realised vols still low but at their highest level since 2011 (22%)

PE of 17 and expected flat S&P performance point towards realised

correl of 35% for the rest of the year
This compares to implied correl of 58% (top 50 ATM), and effective correl
of circa 50%
Below the 60% threshold
But 6M 90/110 skew at 9% is near all-time highs

37

S&P Dispersion: History vs Forecasts

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

6M Disperesion P&L (100 vega)

500

50%
40%
30%

20%
10%

-2000

0%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

38

Mixed Outlook For SX5E Dispersion

SX5E dispersion has yielded disappointing results since 2014
Low to outright negative correlation P&L as SX5E has continued to realise over 60%
despite the rally
Low realised volatilities helped mitigate losses in 2014

Mixed outlook for realised correl

SX5E PE ratio (16) at highest on record, which points towards 40% realised correl
according to S&P experience but will this hold for SX5E?
SX5E expected to rally up to 10% by year end (Credit Suisse Strategys target price:
3,900), which in the past has been associated with realised correl of 50% and higher
One should not overestimate the impact of M&A activity

Implied correl of 65% (6M, ATM) but effective correl of 60%

High, but lower than the optimal threshold when SX5E dispersion typically requires a
higher effective correlation than S&P in order to post a profit
6M 90/110 skew at 5% is low compared to history
39

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

6M Disperesion P&L (100 vega)

SX5E Dispersion: History vs Forecasts

50%
40%

Implied 6M

30%

Realised 6M

20%

Forecast

10%
0%
2009

2011

2013

40

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to
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2014, CREDIT SUISSE

Stanislas Bourgois, Equity Derivatives Strategy

7 Oct 2014

41