Correlation trading

From Wikipedia, the free encyclopedia

In finance, correlation trading is a strategy in which the investor gets exposure to the average correlation of an index.

The key to correlation trading is understanding the principle of diversification -- that the volatility of a portfolio of securities is less than (or equal to) the volatility of a single security in that portfolio. The lower the correlation among the individual securities, the lower the overall volatility of the entire portfolio.

To buy correlation, investors can:

• buy a portfolio of options on the index and sell a portfolio of options on the individual constituents of the index.
• buy a variance swap on the index and sell the variance swaps on the individual constituents.