Hedge Out S&P 500 Correlation

[ttubson]

I'm trying to get exposure to just the NCREIF Timber Index, but the problem is that both of the ETFs are very highly correlated to the S&P 500 and not the Timber Index. So, I looked up all the stocks in the two ETFs designed to track the Timber Index- CUT and WOOD. I then decided to do a regression of those stocks against the Timber Index and the S&P 500. Some of those stocks have a pretty high correlation to the Timber Index and when you throw in the S&P 500, the adjusted R squared goes up to around 80%.

My question is, is there a way to hedge out the S&P 500 correlation? Could I buy quarterly put options on the S&P 500 to hedge out market exposure and get a higher correlation to the Timber Index? How would I backtest this strategy?

 

[Lyosha]

buy whatever it is you want to buy, and sell S&P 500 futures. The ratio you would have to get via backtest (i.e. a regression).

 

[aaronhotchner]

Wouldn't you just be capturing a random variable at that point? If the same underlying information (good economy) results in a big S&P 500 movement and a slightly higher/lower movement for Timber, the only thing you'd hedge away is the S&P gain. Theoretically, if there's a high correlation between the indices, hedging one against the other is just like taking a smaller position in Timber.

 

[ttubson]

That would be the case for the ETFs, but some of the stocks in the index have a much higher correlation to the timber index, which is itself not correlated to the S&P. And I'm hoping that hedging out the S&P 500 variability improves the correlation between the individual stock and the timber index.

 

[DominiConnor]

The thing is that there is inevitably a correlation with the S&P since they both reflect a view on future of the economy.