Cl,apter 31: Index Spreading 587 
Volatility Differential. A theoretical "edge" that sometimes appears is that of 
volatility differential. If two indices are supposed to have essentially the same volatil­
ity, or at least a relationship in their volatilities, then one might be able to establish 
an option spread if that relationship gets out ofline. In such a case, the options might 
actually show up as fair-valued on both indices, so that the disparity is in the volatili­
ty differential, and not in the pricing of the options. 
OEX and SPX options trade with essentially the same implied volatility. 
Thus, if one index's options are trading with a higher implied volatility than the 
other's, a potential spread might exist. Normally, one would want the differential 
in implied volatilities to be at least 2% apart before establishing the spread for 
volatility reasons. 
In any case, whether establishing the spread because one thinks the cash index 
relationship is going to change, or because the options on one index are expensive 
with respect to the options on the other index, or because of the disparity in volatili­
ties, the spreader must use the deltas of the options and the price ratio and volatili­
ties of the indices in setting up the spread. 
Striking Price Differential. The index relationships can also be used by the 
option trader in another way. When an option spread is being established with 
options whose strikes are not near the current index prices - that is, they are rela­
tively deeply in- or out-of-the-money- one can use the ratio between the indices to 
determine which strikes are equivalent. 
Example: ZYX is trading at 250 and the ZYX July 270 call is overpriced. An option 
strategist might want to sell that call and hedge it with a call on another index. 
Suppose he notices that calls on the UVX Index are trading at approximately fair 
value with the UVX Index at 175. What UVX strike should he buy to be equivalent 
to the ZYX 270 strike? 
One can multiply the ZYX strike, 270, by the ratio of the indices to arrive at the 
UVX strike to use: 
UVX strike= 270 x (175/250) 
= 189.00 
So he would buy the UVX July 190 calls to hedge. The exact number of calls to 
buy would be determined by the formula given previously for option ratio.