wilmott.com

lets imagine we have a european call option whose claim is a (linear) function of by how much one equity index outperforms another. For instance say we buy a call on the eurostoxx -- dax spread (esx-dax) at strike 0%, maturity T. If we assume a 'no smile' world to price this option would not be too difficult (if we knew the imp vols and correlation between esx and dax), however my question is a practical one: Is it possible to synthetically replicate the payout using the futures and options markets on the equity indices?thanks tom

I would say NO

i am open to correction but isn't the DAX a total return index so you would expect it to outperform the eurostoxx which is a price return index? ignoring that, you are unlikely to be able to replicate the payout so it is a question of how much you charge for the correlation.