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Total Posts: 31
Joined: Aug 2018
Posted: 2020-07-01 15:29
Hi everyone,

Lets say SPY has only 2 components, AAPL and AMZN. I want to do a dispersion trade however I might not want to trade a 3rd leg.

I use Margrabe formula and find out what the implied vol of AMZN should be given historical correlations between AAPL and SPY and implied vols.

SPY IVol = 15%
AAPL IVol = 20%
SPY/AAPL correlation = .90

Margrabe Formula:
AMZN Vol = sqrt(.15^2 + .20^2 - 2*.15*.20*.90)
AMZN Vol = 9.2%

I look into the options market and see AMZN Implied vol at 5%!

Should I buy the straddle on AMZN or just delta hedge with AMZN if it starts to move too much. What might be the pros and cons.

Thank you for taking the time to help answer this.

men lie, women lie, numbers don't


Total Posts: 121
Joined: Dec 2007
Posted: 2020-07-03 13:11
>Lets say SPY has only 2 components, AAPL and AMZN

Probably this is why your impvols for AMZN do not match. Going from 500 to 2 is likely too much of a shortcut.

No vanna, no cry


Total Posts: 31
Joined: Aug 2018
Posted: 2020-07-05 06:38
Hi @frolloos, thanks for getting back to me. This was actually a theoretical example, not directly for the S&P. Simply a 2 component index.

men lie, women lie, numbers don't


Total Posts: 1143
Joined: Jun 2005
Posted: 2020-07-05 09:13
You might find this useful

Specifics of hedge strategy depends on transaction costs, liquidity of hedges etc etc Backtest them


Total Posts: 31
Joined: Aug 2018
Posted: 2020-07-06 04:08
Frolloos, I am still a bit confused on how to manage this trade. I could do it Vega (notional) neutral. Or I could do it AAPL vs SPY theta neutral and hedge with AMZN + AAPL shares.

Just a reminder, this is not for the actual SPY etf but a theoretical product with only 2 components

men lie, women lie, numbers don't

Nuclear Energy Trader

Total Posts: 1344
Joined: May 2004
Posted: 2020-07-08 22:48
modesty prevents me from coming right out in naming the applicable paper for the two asset case but you might want to Google " commodity covariance contracting"

flaneur/boulevardier/remittance man/energy trader


Total Posts: 836
Joined: Jun 2005
Posted: 2020-08-06 21:04
TonyC, It has been so long since those HR Correlation days! Are you hedging your APPL and AMZN punt with Natty vol? :)
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