While the VIX index has recently dropped to levels close or below those prior to the Lehman bankrupcy, the implied correlation index, which was recently launched to measure the correlations between all stocks in the S&P 500, has not dropped as much. The CBOE has published a white paper on the subject, and meat of the discussion is below ..
The significance of implied correlation is that it reflects changes in the relative premium between index options and single-stock options, providing trading signals for a strategy known as volatility dispersion (correlation) trading. Commonly, 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.
So while equity index volatility has come lower and correlation has remained high, the volatility on single stock options hasn’t reduced as much as you would expect by looking at the volatility on the index only. Markets predict that overall volatility will be lower and the outperformance of the winners versus the losers will also be smaller.
Implied correlation
Implied volatility
