Hedge funds heavily exposed to equity dispersion strategies are looking to upcoming technology earnings to revive volatility, following a period of declining share-price swings that has weighed on the trades, according to a report by Bloomberg.

Results from major semiconductor and artificial intelligence companies are expected to be a key catalyst, alongside a Federal Reserve meeting and the US midterm elections.

Dispersion strategies typically involve buying options on individual stocks while taking an offsetting position in index volatility. The approach aims to profit when constituent stocks experience different price movements, rather than moving in tandem with the broader market. Earnings season can provide favourable conditions as company-specific results and guidance become more influential than macroeconomic drivers such as interest rates and oil prices.

However, the latest decline in single-stock volatility has put pressure on investors running the strategy, leaving some positions with significant mark-to-market losses. Traders are now watching closely for updates on AI demand and semiconductor spending that could trigger the larger share-price moves needed to improve performance.

The report cites Alexis Maubourguet, chief investment officer at Adapt Investment Managers, as saying that dispersion positions had been rebuilt aggressively following a pullback in July associated with the Situational Awareness unwind. Strong recent performance and fund incentive structures had encouraged managers to increase exposure, leaving some investors vulnerable as the trades subsequently moved against them.

The current downturn has also presented a different risk profile from previous episodes. The narrowing premium of semiconductor implied volatility over the S&P 500 Index has coincided with weaker realised volatility, while correlations between stocks have remained relatively low. This contrasts with the dispersion losses following the US-Israeli attack on Iran, when a sharp increase in implied correlation played a significant role, even as realised volatility remained more supportive.

Maubourguet said the market's earlier enthusiasm for technology stocks had diminished, reducing demand for expensive upside options and weakening the traditional dispersion trade as both implied and realised volatility spreads contracted.

The latest earnings season could therefore prove important in determining whether managers maintain their positions or reduce exposure. Although the exceptional share-price moves recorded during first-quarter earnings may be difficult to replicate, options markets are pricing in the largest one-day earnings reactions since the Covid-19 pandemic, according to UBS derivatives strategist Kieran Diamond. Technology stocks are expected to see some of the biggest moves.

These expectations may encourage hedge funds to remain invested despite having surrendered part of their earlier gains. For other investors, lower equity volatility has created an opportunity to establish or increase positions at more attractive levels.

Industry data compiled by Premialab indicates that technology-focused quantitative investment strategy dispersion portfolios have suffered the most significant pressure. The findings suggest recent losses have been concentrated in technology-heavy baskets rather than reflecting a widespread deterioration across systematic dispersion strategies, according to Premialab chief executive Adrien Geliot.

A renewed macroeconomic shock could present a further challenge. An escalation in the US-Iran conflict or disruption in bond and currency markets could cause equities to move more closely together, undermining the relative performance of dispersion positions. Such a shift could also improve the appeal of reverse dispersion trades, which involve selling volatility in individual stocks while buying index volatility.

The outcome is also relevant for traders positioning around the Cboe Volatility Index (VIX). A forced unwinding of crowded dispersion positions could amplify movements in the volatility benchmark. Investors have recently used November VIX call spreads to hedge against potential market turbulence surrounding the US midterm elections.

Maubourguet warned that the decline in individual-stock volatility could be followed by a rise in broader index volatility, potentially triggering further position reductions. A sharp daily fall in the S&P 500, for example, could prompt investors to unwind trades, adding to market volatility at a time when many funds are already under pressure.