The Impact of Dispersion on Market Expectations and Volatility

Dispersion measures how much the returns of individual stocks differ from each other over a given period. In periods of high dispersion, some stocks greatly outperform others. When dispersion is low, most stocks result in similar returns. Dispersion is the opposite of correlation. Realized correlation can be tracked using the actual returns of stocks or ETFs, while the expected future correlation can be estimated from the implied volatility of individual stocks compared to index volatility. The Cboe DSPX^SM Index provides a real time and historical measure of implied dispersion of major stocks in the S&P 500^® versus the index volatility itself. 

Over the past six months, we can see how a number of sector ETFs have performed, led by XLY (consumer goods and services) and XLF (financials) with returns near 20%, while XLV (health care) and XLE (energy) have lagged. Returns for the S&P 500 Index line up near the center of the data, illustrating the diversification that passive investors expect.

ETF Performance 2025

^{Source: Cboe Global Markets}

By contrast, the early part of 2022 saw a high concentration of returns - with the exception of XLE (energy) that was up sharply as travel began to boom post pandemic. This relatively low dispersion environment is common during broad market downturns such as that seen in 2022, where investors reduced holdings across all investments as a defensive move. 

ETF Performance 2022

^{Source: Cboe Global Markets}

Higher dispersion generally leads to lower index volatility, even if realized volatility is increasing for many individual stocks (or by extension, sector ETFs) because component moves tend to cancel out at the index level. This is one reason the Cboe Volatility Index^® (the VIX^® Index) has trended lower this year as dispersion, both in realized and implied form, has increased.

Cboe Volatility Index (VIX)

^{Source: Cboe LiveVol}

Cboe S&P 500 Dispersion Index (DSPX)

^{Source: Cboe LiveVol}

At the institutional level, dispersion can be traded in large portfolios that short index volatility in some form against long volatility holdings in individual stocks. Quantitative trading teams put a great deal of work into the asset selection and mechanics of this strategy, which can involve a large book of listed and OTC derivatives and a robust risk management approach.

For advanced retail option traders, understanding dispersion is very helpful in knowing what to expect from investment choices. The Cboe DSPX Index provides a helpful guide to market expectations - with current levels suggesting traders expect dispersion to remain relatively high in the near future, rewarding traders who manage to select the winners and avoid (or short) the losers - easier said than done.

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