The Big Trade Underneath the Strangely Calm Surface of the S&P 500

Tracy Alloway (0:02)

Bloomberg Audio Studios. Podcasts, radio, news.

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:23)

And I'm Joe Weisenthal.

Tracy Alloway (0:24)

Joe, how would you describe current market conditions?

Joe Weisenthal (0:28)

Up and to the right, every day, basically. We're recording this June 13, and we're probably at new highs in the futures. Yeah, everything just goes up all the time, and it's pretty easy.

Tracy Alloway (0:38)

Yeah, but even when you say up and to the right, if you're looking at something like the S&P 500, I mean, it's gone up a lot, but on a day like Wednesday when we had the FOMC decision and we had inflation data coming in softer than expected, even then, the S&P 500 was up by like less than a percent.

Joe Weisenthal (0:59)

Yeah, but you add up a bunch of less than a percent, and you put together a historical year of returns. I mean, it is-

Tracy Alloway (1:05)

Yeah, but no one wants to wait for all those days to pile up. So if you look at the single stocks, I mean, there have been days when Nvidia was up like almost 10%.

Joe Weisenthal (1:15)

So this is the thing, you're right. And this is the thing about the market, which is like, I am like a boring S&P 500 every month, like put a few dollars into some ETF, but then I see other people around me getting like really rich because they bought Nvidia and it's really annoying.

Tracy Alloway (1:32)

What if I told you there was a way that you could square those two things? So boring indices and the volatility in single stocks.

Joe Weisenthal (1:42)

I don't want the volatility in single stocks. I don't want the upside of single stocks. Yes, if I can have both getting really rich and being boring, that's fine too.

Tracy Alloway (1:50)

Okay, so today we're going to be talking about something that I've wanted to do an episode on for a long time. We are going to be talking about the dispersion trade. Have you heard about that?

Joe Weisenthal (2:01)

No, I mean, basically other than the prep that I did for this episode 15 minutes ago, no.

Tracy Alloway (2:06)

I'm gonna try not to be offended because I did write about it a few months ago, which you should, actually I wrote a story about it and I wrote a newsletter, an Odd Lots newsletter, Joe. Yeah, okay.

Joe Weisenthal (2:17)

Go on.

Tracy Alloway (2:18)

All right, it's a good thing we're having this conversation then. Okay, the dispersion trade. So basically it sort of falls into the bucket of another type of short vol trade. And the idea-

Joe Weisenthal (2:28)

I sort of knew that. I sort of knew that.

Tracy Alloway (2:30)

Okay, good, we're getting somewhere. The idea is basically you have traders that are using equity options to bet on, this is the important thing, the relative volatility between single stocks and stock indexes.

So, you know, typically you might see someone go long volatility in a basket of individual stocks using single stock options, while simultaneously betting that volatility in an index, like the S&P 500, is gonna stay relatively low.

Joe Weisenthal (3:01)

So implicitly, I guess there's an opportunity to sell that volatility to the people hedging a portfolio and then doing the other side on the other side.

Tracy Alloway (3:10)

Yeah, that's exactly it. So you kind of need two things for this to work. You need the market dynamics to basically be volatile, single stocks and kind of boring overall benchmark indices. But you also need the cost to make sense. So when you're buying that volatility, it all has to kind of net out. But recent months for a while now, that has been the case.

And there's a lot of anecdotes on Wall Street that this trade is absolutely booming.

Joe Weisenthal (3:37)

Yeah, I mean, we talk about these from time to time on the show. Sometimes it's expressed more directly in some sort of implicit short VIX trade. Sometimes it's talked about very explicitly, like a few years ago, I don't know, 2018 or whatever, like the real short VIX trade that blew up and everyone stayed in. The Volmageddon trade. I don't remember what year that was, like 2017 or 2018, or something like that. But from time to time, one thing that seems to be clear is that there are various flavors of trades that become very popular, and all that needs to happen is for roughly, you don't even need the market to go up or anything like that. You just roughly need the status quo to persist.