I am confused on how to compute the spread ratio. For example, this is example I came across with my broker - Consider 2 contracts Bobl and Euribor. The DV01 of Bobl i 44.8 and Euribor is 25. To equalize DV01, we need 44.8/25=1.792 contracts of Euribor for every 1 contract of Bobl. However, tick sizes are different. 1 Bobl Tick is 10 Euros and similar Euribor tick is 25. So the ratio will be for 1 Bobl we need 1.79*(25/10) = 4.475 contracts of Euribor. I understand DV01 sensitivity to compute the hedge ratio. However, I don't understand how is he using tick sizes. If he related tick sizes to basis points, it would have made more sense to me. Does someone understand this? Thanks
Tick sizes are irrelevant. Ratio of DV01s is the only thing that matters. Using the Dec Bobl contract, you will get to a ratio of roughly 2.25 (56.5 vs 25). P.S.: I also responded on your other thread.
Thanks for the reply and sorry for duplicate post as I lost my first post thought it didn't get posted. Wouldn't the tick size matter if the contracts have different tick sizes in terms of basis points? But in this case, it seems they have the same tick size - 0.01 representing 1 basis point change. So I don't understand what the author of the article that I quoted is trying to do.
I have no idea what the author of your article is trying to do. Tick size is irrelevant (and it doesn't represent 1 basis point change every time). What matters is the contract spec, i.e. the notional and the underlying. The contract spec determines the DV01 of the contract and that's all you need. Tick size doesn't come into it.