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Mistro


Total Posts: 32
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

frolloos


Total Posts: 126
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

Mistro


Total Posts: 32
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

nikol


Total Posts: 1230
Joined: Jun 2005
 
Posted: 2020-07-05 09:13
You might find this useful

https://arxiv.org/abs/0904.4822

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

Mistro


Total Posts: 32
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

TonyC
Nuclear Energy Trader

Total Posts: 1352
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

doobs


Total Posts: 838
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? :)

TonyC
Nuclear Energy Trader

Total Posts: 1352
Joined: May 2004
 
Posted: 2020-08-10 18:20
Made a modest seven-figure sum on the drop of oil from 40 to 30, (this was the OPEC meeting, before oil went negative)

Unfortunately lost a much bigger 7 figure sum in deep value equities during the corona crash

Net-net, I am still floating 15 or 17% below where I was on January 1st

flaneur/boulevardier/remittance man/energy trader

doobs


Total Posts: 838
Joined: Jun 2005
 
Posted: 2020-08-10 19:12
TonyC, Trying hard to Die With Zero?
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