Sell Samsung Electronics Volatility and Buy KOSPI 200 Volatility
Feb 18, 2004
The three month implied volatility spread between Samsung (bid) and KOSPI 200 (ask) is 9%, which is roughly +1.8 standard deviation higher than the 3 month average volatility spread. Investors can consider selling 3 month ATM puts on Samsung Electronics and buying 3 month ATM puts on KOSPI 200. Investors will receive 7% from selling put options on Samsung Electronics and will have to pay around 4.8% to buy puts on KOSPI 200 index. The net premium received by investors would be around 2.2%.
This strategy would be initiated by investors who believe that there is a general weakness in the Korean market and that KOSPI 200 has a lot more downside to it, however, the exporters and IT players like Samsung Electronics would continue to outperform.
The biggest risk in these kinds of trade is the “correlation risk”. If the general Korean equity markets starts to fall and KOSPI 200 becomes more volatile (the long puts will benefit) it may quickly start to drag down stocks like Samsung. This would have nothing to do with the fundamentals of the stock but rather would be induced by correlation between KOSPI 200 and Samsung becoming more positive and moving towards one. Often volatility investors overlook the risk of correlation, which can result in bigger loss. In a trade like the above correlation – and not just the historical correlation, but the implied correlation (as implied by option prices) – needs to be monitored very closely.
The above trades can be effectively hedged, though it may prove physically cumbersome to execute, by creating correlation trades on the underlying variables.
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