The CBOE® S&P 500® Implied Correlation Index

The CBOE S&P 500^® Implied Correlation Index

The CBOE S&P 500 Implied Correlation Index is the first widely disseminated, market-based estimate of the average correlation of the stocks that comprise the S&P 500 Index (SPX). Using SPX options prices, together with the prices of options on the 50 largest stocks in the S&P 500 Index, the CBOE S&P 500 Implied Correlation Index offers insight into the relative cost of SPX options compared to the price of options on individual stocks that comprise the S&P 500.

 

• CBOE began disseminating daily values for the CBOE S&P 500 Implied Correlation Index in July 2009, with historical values back to 2007.
• CBOE calculates and disseminates two indexes tied to two different maturities, usually one year and two years out. The index values are published every 15 seconds throughout the trading day.
• Both are measures of the expected average correlation of price returns of S&P 500 Index components, implied through SPX option prices and prices of single-stock options on the 50 largest components of the SPX.
• Ticker symbols JCJ, KCJ and ICJ:
  • JCJ - calculated through Nov 2010 expiration, using Dec 2010 SPX options and Jan 2011 equity LEAPS options
  • KCJ - calculated through Nov 2011 expiration, using Dec 2011 SPX options and Jan 2012 equity LEAPS options
  • ICJ - will be added in Nov 2010 using Dec 2012 SPX options and Jan 2013 equity LEAPS

The CBOE S&P 500 Implied Correlation Index may be used to provide trading signals for a strategy known as volatility dispersion (or correlation) trading. For example, a long volatility dispersion trade is characterized by selling at-the-money index option straddles and purchasing at-the-money straddles in options on index components. One interpretation of this strategy is that when implied correlation is high, index option premiums are rich relative to single-stock options. Therefore, it may be profitable to sell the rich index options and buy the relatively inexpensive equity options.

"One of the perceived benefits of owning a portfolio of stocks is diversification related to the correlation between stocks. While less correlation between stocks in a portfolio typically leads to greater diversification, the correlation between stocks is constantly changing, and in times of market stress the correlation increases as stock prices tend to move together. As a result, the diversification benefits of a portfolio of stocks may be less than initially anticipated."
--- Joe Levin, CBOE Vice President of Research and Product Development

About the CBOE S&P 500® Implied Correlation Index

The CBOE S&P 500 Implied Correlation Index measures changes in the relative premium between index options and single-stock options. A single stock's volatility level is driven by factors that are different from what drives the volatility of an Index (which is a basket of stocks). The implied volatility of a single-stock option simply reflects the market's expectation of the future volatility of that stock's price returns. Similarly, the implied volatility of an index option reflects the market's expectation of the future volatility of that index's price returns. However, index volatility is driven by a combination of two factors: the individual volatilities of index components and the correlation of index component price returns.

Intuitively, one would expect that the implied volatility of an index option would rise with a corresponding change in the implied volatilities of options on the index components. Yet, there are times when index option implied volatility moves and there is no corresponding shift in implied volatilities of options on those components. This outcome is due to the market's changing views on correlation. The relationship between the implied volatilities of options on an index and the implied volatilities of a weighted portfolio of options on the components of that index, therefore, becomes a measure of the market?s expectation of the future correlation of the index components - the "implied" correlation of the index.

For example, from November 20, 2008, through May 29, 2009, the closing value of ICJ ranged from a low of 56.54 on November 21, 2008, to a high of 74.78 on March 20, 2009. During the same time period, the CBOE Volatility Index (VIX) declined significantly from a record-high close of 80.86 on November 20, 2008 to around 40 in mid-March and 29 at the end of May. Conversely, ICJ remained relatively high with a closing value of 58.94 recorded on June 30, 2009, possibly signaling an expectation that equity prices would continue to move together.

 

More Information

CBOE S&P 500 Implied Correlation Index White Paper
S&P 500 Implied Correlation Historical Data
Delayed Quotes

Other CBOE Volatility Strategy Benchmarks

CBOE VIX Premium Strategy Index - VPD
CBOE Capped VIX Premium Strategy Index - VPN
CBOE S&P 500 VARB-X Strategy Benchmark - VTY
CBOE S&P 500® 3-Month Volatility Index® - VXV

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