Dispersion traders have seen substantial profits this year by capitalizing on the dramatically divergent movements of US stocks, a trend fueled by the AI boom. This strategy involves selling options on an index like the S&P 500 while buying options on individual stocks, profiting when individual stocks are more volatile than the index. Correlation, which measures how much stock prices move together, has plummeted to near-record lows, providing an ideal environment for these trades. Neeraj Chaudhary, head of EMEA equity exotics at Bank of America, described returns for dispersion traders as "phenomenal." Historically, this period represents one of the highest levels of dispersion ever observed in the market, with the S&P Software & Services Select Industry Index down 15% in 2026, while the S&P 500 Energy subindex jumped about 20%.
However, despite the current profitability, investors are growing cautious. Many are cashing in their dispersion profits, and some are even beginning to explore "reverse dispersion" trades, albeit in much smaller sizes. These reverse trades anticipate a return to higher correlation, where stocks begin to move in sync again. Garrett DeSimone, head of quantitative research at OptionMetrics, noted that the current low implied correlation is leading investors to question how much more profit can be extracted from dispersion and if the risks are still warranted. The Cboe’s three-month implied correlation index is near all-time lows, making dispersion trades riskier than in the past, according to DeSimone.
The shift to reverse dispersion reflects concerns that the market dynamics are stretched and that correlation could aggressively spike, potentially derailing existing dispersion strategies. Kieran Diamond, a derivatives strategist at UBS, highlighted that AI stocks have predominantly driven the recent equity rally, making a challenge to the AI narrative a significant risk for these trades. A selloff in AI stocks, potentially triggered by rising interest rates or a broader market correction, could lead to a sharp increase in correlation. While a market shock could negatively impact dispersion trades, some analysts believe a return of correlation could also present an attractive entry point for long-term dispersion positions, as seen during the war-induced market volatility in March, when BNP Paribas observed increased client interest despite a drawdown in performance.
