I have a dispersion question I need help with...An index SPY has only 2 components - AAPL and AMZN. We are given the implied volatility of SPY and AAPL as well as the correlation between the 2 assets. SPY IV = 20% AAPL IV = 25% Correlation SPY/AAPL = 85%.
We then use Margrabe formula to back out the fair value implied vol for AMZN... AMZN vol = sqrt(.20^2 + .25^2 - 2*.25*.20*.85) AMZN vol = 13%
We take a look at the options market and AMZN vol is trading for 5%. How would you trade this? Obv we want to buy vol on amzn, but specifically how would you do it? Would you trade strangles, atm straddles? etc.. Also we get penalized for adding more legs to the position.