Chpt,r 31: Index Spreading 581 
J!"<>r example, if one index sells for twice the price of the other, and if both indices 
have similar volatilities, then a one-to-one spread gives too much weight to the 
higher-priced index. A two-to-one ratio would be better, for that would give equal 
weighting to the spread between the indices. 
Example: UVX is an index of stock prices that is currently priced at 100.00. ZYX, 
another index, is priced at 200.00. The two indices have some similarities and, there­
fore, a spreader might want to trade one against the other. They also display similar 
volatilities. 
If one were to buy one UVX future and sell one ZYX future, his spread would 
be too heavily oriented to ZYX price movement. The following table displays that, 
showing that if both indices have similar percentage movements, the profit of the 
one-by-one spread is dominated by the profit or loss in the ZYX future. Assume both 
fi1tures are worth $500 per point. 
Market ZYX ZYX uvx uvx Total 
Direction Price Profit Price Profit Profit 
up 20% 240 -$20,000 120 +$10,000 -$10,000 
up 10% 220 - 10,000 110 + 5,000 - 5,000 
down 10% 180 + 10,000 90 - 5,000 + 5,000 
down 20% 160 + 20,000 80 - 10,000 + 10,000 
This is not much of a hedge. If one wanted a position that reflected the movement 
of the ZYX index, he could merely trade the ZYX futures and not bother with a 
spread. 
If, however, one had used the ratio of the indices to decide how many futures 
to buy and sell, he would have a more neutral position. In this example, he would buy 
two UVX futures and sell one ZYX future. 
Proponents of using the ratio of indices are attempting strictly to capture any 
performance difference between the two indices. They are not trying to predict the 
overall direction of the stock market. 
Technically, the proper ratio should also include the volatility of the two indices, 
because that is also a factor in determining how fast they move in relationship to each 
other.