Tradable Correlation

S

Spaghetti Code

Sorry for a possibly dumb question, but why isn't asset correlation a tradable security? For example, suppose I want to buy stock in two companies, but they are highly correlated. If there was some instrument that I could short, representing the correlation between the two, I could hedge against the two moving the same direction.

One way of constructing such an instrument would be to make an leveraged ETF that has a payoff of 1xA multiplied by 1xB. When stock AAA goes up by 1%, and Stock B goes up by 2%, the return of this ETF could be AxB, or 3.02%. In effect, it would be correlation between the two. This would be similar to the 2x and 3x ETFs available for trade today, but instead of linear multiple of one stock, it would be the product of the two.

Getting specific, I like both SPY and DIS. DIS has a high amount of market correlation to SPY, so it doesn't add much value to my portfolio. If there was a SPYDIS ETF which represented the correlation between the two, I could short it, and get the diversification. Alternatively, I could go long SPYDIS, and short the components.
 
Spaghetti Code said:
Sorry for a possibly dumb question, but why isn't asset correlation a tradable security? For example, suppose I want to buy stock in two companies, but they are highly correlated. If there was some instrument that I could short, representing the correlation between the two, I could hedge against the two moving the same direction.

One way of constructing such an instrument would be to make an leveraged ETF that has a payoff of 1xA multiplied by 1xB. When stock AAA goes up by 1%, and Stock B goes up by 2%, the return of this ETF could be AxB, or 3.02%. In effect, it would be correlation between the two. This would be similar to the 2x and 3x ETFs available for trade today, but instead of linear multiple of one stock, it would be the product of the two.

Getting specific, I like both SPY and DIS. DIS has a high amount of market correlation to SPY, so it doesn't add much value to my portfolio. If there was a SPYDIS ETF which represented the correlation between the two, I could short it, and get the diversification. Alternatively, I could go long SPYDIS, and short the components.
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You can trade correlation via options. Google dispersion trading
 
Such product/ETF would have no underlying assets ? Kinda like crypto made out of thin air ?

Then Walstreet would looove this idea.
 
MrMuppet said:
You can trade correlation via options. Google dispersion trading
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Interesting approach, but I suspect that is the stuff of MMs. I suspect it would also be hard to trade that in my small account, since the offset of the index options with index futures would blow my non-portfolio margin out.
 
You need a larger account (or portfolio margin) to get the ratios right, yes.

But honestly, if you just want to hedge out the overall market, you can just setup a long/short (e.g. SPY short/long DIS) portfolio.
 
Yes, that’s right. A small account won’t work. You will need to have a bigger account to make that happen. Try setting up your portfolio again according to whether you want to go long or short.
 
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