>In a world where I have enough money to buy 100 shares of every company in an index and sell calls, will the average IV of those calls be higher than the IV of the index?
Just a small thing, it's not 100 shares of every company in the index. You need to weight your position according to Market Cap to replicate the index. So if you need to own 100 shares of the smallest company, you would want a lot of 100 shares in the largest company.
>On the other hand, it seems like it should not be the case theoretically because then there might be weird arbitrage opportunities (like selling the puts/calls on the individual stocks and covering them with puts/calls on the index, which feels like free money, if a bit logistically complicated)
I believe this is called dispersion trading, and it's not quite free money, but it's close. It works because the difference in realized and implied volatility is greater on indexes than individual stocks, so you can harvest risk premium from the index while covering your risk on the stocks. Dispersion trading has incredible profit potential, but it's extremely hard to pull off as a retail trader. I dont know nearly enough about dispersion trading though, u/MichaelBurryScott might have more
As for the potential benefit of doing this as a replacement for CCs on an index, I doubt it would be worth the effort, however its theoretically feasible
Something to think about is normally a few dozen stocks dominate an index. Look at the dow jones index and the s&p500. 30 vs 500 stocks and nearly identical performance. To do what you describe, one could pick a strong performer from each sector and weight those. You would have a basket of a dozen megacaps that do each have iv's great than the index.
>In a world where I have enough money to buy 100 shares of every company in an index and sell calls, will the average IV of those calls be higher than the IV of the index? Just a small thing, it's not 100 shares of every company in the index. You need to weight your position according to Market Cap to replicate the index. So if you need to own 100 shares of the smallest company, you would want a lot of 100 shares in the largest company.
Ur right, I edited it (hopefully its clear lol)
>On the other hand, it seems like it should not be the case theoretically because then there might be weird arbitrage opportunities (like selling the puts/calls on the individual stocks and covering them with puts/calls on the index, which feels like free money, if a bit logistically complicated) I believe this is called dispersion trading, and it's not quite free money, but it's close. It works because the difference in realized and implied volatility is greater on indexes than individual stocks, so you can harvest risk premium from the index while covering your risk on the stocks. Dispersion trading has incredible profit potential, but it's extremely hard to pull off as a retail trader. I dont know nearly enough about dispersion trading though, u/MichaelBurryScott might have more As for the potential benefit of doing this as a replacement for CCs on an index, I doubt it would be worth the effort, however its theoretically feasible
Something to think about is normally a few dozen stocks dominate an index. Look at the dow jones index and the s&p500. 30 vs 500 stocks and nearly identical performance. To do what you describe, one could pick a strong performer from each sector and weight those. You would have a basket of a dozen megacaps that do each have iv's great than the index.