This is a real life trade situation where there is no margin requirements due to bilateral nature of the deal.
At all periods in time, I have to two assets A, B in my portfolio of quantity 1 each.
Day 1:
Stock A is at $100
Stock B is at $101
SpreadAB = $1
Day 2:
Stock A is at $110
Stock B is at $101
SpreadAB = $9
Calculations:
Stock A returns = 10%
Stock B returns = 0%
Portfolio returns = (10% - 0%)/2 = 5%
But for calculating the volatility of portfolio I need to find weights of A and B in portfolio, what are the weights for A and B in such spread portfolio.
I intend to use the formula:
w_A^2 * Sig_A^2 + w_B^2 * Sig_B^2 - 2*rho_A_B * w_A * w_B * Sig_A*Sig_B