What is the dispersion trade

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Suppose that the AB2 is an equally-weighted stock index of two stocks; it is designed as simply the sum of the two stocks’ prices. Stock A has a volatility of .2, stock B has a volatility of .4, and the current correlation between the two stocks is .5. Suppose you believe that the correlation between the stocks is going to rise to .75. Six-month at-the-money call options exist on the individual two stocks and on the index. The current (annualized) six-month interest rate is 4%. What is the dispersion trade?

Reference no: EM13732299

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