Wild gyrations in individual stocks on a punchy cocktail of AI euphoria and fear, a tumbling bond market and geopolitical drama bode well for a long-favored trade among hedge fund managers.
Optimism swirling around advances including Meta Platforms Inc.' new Muse AI agent has been countered by concern that rapid growth in the sector could harm businesses from banks to travel agents. That's sent stocks swinging in opposite directions, as has a stream of headlines from wars in Iran and Ukraine that whipsawed shares of oil producers and refiners. Meanwhile, Treasury yields reached the highest in two decades, driving up borrowing costs.
"One thing that clients have been inquiring about as of late has been this agentic AI winner-and-loser narrative," said Alex Kosoglyadov, head of flow equity-derivatives sales at Nomura Holdings Inc. "Who benefits from growth of the agentic AI revolution, or if you will, who's vulnerable to that?"
ALSO READ: Gas Vs Green: Who Wins Under Trump's Relaxed Fuel Rules That Ends Biden's EV Mandate?
The winners versus losers scenario around AI, oil and rates sets up an ideal situation for the dispersion trade, as stocks within a gauge such as the S&P 500 Index heading in different directions dampens its swings.
| Single-stock implied volatility has contracted since late July - especially for high-flying technology names - making the dispersion trade more attractive to enter. "From an entry standpoint, things are relatively on sale versus where they were not so long ago as single stock vols have compressed," said Matthew Davis, director of flow derivatives trading at RBC Capital Markets. The spread between single-stock volatility and the S&P 500 is beginning to widen again as traders buy options on individual stocks while selling contracts on the index to profit from the divergence. That may continue with earnings season coming up, a time when stocks tend to move idiosyncratically based on their own stories, rather than all together in response to some macro catalyst. There was a wave of options buying seen in AI-related names over the past couple of weeks, a sign of investors reloading for further action. Realized one-month absolute return for S&P 500 members versus the index increased to the 95th percentile over the past 30 years, according to a note from Charlie McElligott, a cross asset strategist at Nomura. Cboe Global Markets Inc.'s one-month correlation index, which had been climbing from July's record low, has fallen back over the past week. Investors can find dispersion trade opportunities within tech, as well as within the energy sector between refiners and oil producers. Shares of software companies and AI firms have been seesawing as the narrative on disruption has shifted. "Price performance of software stocks has shown that the market believes that AI is not going to be the ender of all software that I think people were concerned that it was," Davis said. "So you have seen shuffling there." That said, dispersion is often seen as a crowded strategy. And not everyone thinks that now is a good entry point. "The trade is due for a washout," said Kris Sidial, co-chief investment officer at hedge fund Ambrus Group. "Dispersion has been in vogue for the last four to five years. It's the same exact trade." While complex dispersion strategies are structured by banks, many hedge funds prefer to build their own, using exchange-traded options. For a market that's running hot and cold, more straightforward hedging playbooks can be effective as well. "It's a very frustrating environment," said Alon Rosin, head of institutional equity-derivatives at Oppenheimer & Co. "Conviction is super low." Investors are best off picking a handful of stocks to back that could lead to profits, Rosin added, while hedging downside using puts on exchange-traded funds like the State Street SPDR S&P 500 ETF Trust and the Invesco QQQ Trust. The uncertainty hasn't kept traders on the sidelines. The average volume was up 14% in August from a year earlier, according to Options Clearing Corp. data. From May to June, OpCo added seven employees as client appetite for options ballooned, according to Rosin. ALSO READ: 'Cheaper Does Not Mean Cheap': India Still Trades At Premium, Says Dheeraj Gaur For the funds entering dispersion plays, there are diverse ways to implement the strategies. "One of the reasons we believe in this trade is because there's something there for everyone," said RBC's Davis. "If you want a more carry-oriented structure, you can sell more index. If you want a more defensive-oriented structure, you don't need to sell as much index." The biggest elephant in the room is AI, which has the potential to impact sectors from semiconductors and retail stores to power generation and real estate. The uncertainty over how much and when it will affect employment and the broader the economy leaves the potential for huge moves in either direction for the most-exposed companies. "AI and the growth and the usage and the GDP impact can lead to much more outsized, longer-term gains in some of these names than anyone can imagine," said Ambrus' Sidial. "But at the same time, if it's not widely adopted and if there are bottlenecks that are falling down within the pipeline, certainly these names could drop 50% plus over the course of the next year." "This is one of the very interesting cases where both tails are kind of underpriced relative to what can actually happen," he said. |
(This story has not been edited by NDTV staff and is auto-generated from a syndicated feed.)
Essential Business Intelligence, Sharp Market Insights, Practical Personal Finance Advice, Daily Fuel, Gold and Silver Prices and Latest Stories — On NDTV Profit.