What is the difference between a variance swap and a volatility swap?
Volatility swaps are forward contracts on future realized stock volatility. Variance swaps are simi- lar contracts on variance, the square of future volatility. Both these instruments provide an easy way for investors to gain exposure to the future level of volatility.
What is variance swap?
A variance swap is a financial derivative used to hedge or speculate on the magnitude of a price movement of an underlying asset. These assets include exchange rates, interest rates, or the price of an index. In plain language, the variance is the difference between an expected result and the actual result.
Is VIX a variance swap?
Regardless its legacy name as a volatility index, VIX is calculated as a variance swap. Unlike an actual swap, variance swap is a forward contract on realized variance. The note provides a link between theoretical pricing of a variance swap and VIX calculation formula.
What is an FX volatility swap?
What Is a Volatility Swap? A volatility swap is a forward contract with a payoff based on the realized volatility of the underlying asset. They settle in cash based on the difference between the realized volatility and the volatility strike or pre-determined fixed volatility level.
Does variance swap have Delta?
Yes. Volatility swaps can have a delta due to the discretization of time and due to volatility surface dynamics in exactly the same way as a variance swap.
How do you hedge a variance swap?
The variance swap may be hedged and hence priced using a portfolio of European call and put options with weights inversely proportional to the square of strike. Any volatility smile model which prices vanilla options can therefore be used to price the variance swap.
What is the Vega of VIX?
India VIX represents the implied volatility over the next 30 days period. Vega measures the rate of change of premium with respect to change in volatility. All options increase in premium when volatility increases. The effect of volatility is highest when there are more days left for expiry.
Is VIX variance or volatility?
The VIX is the volatility of a variance swap and not that of a volatility swap, volatility being the square root of variance, or standard deviation.
Can retail traders trade variance swaps?
Variance swaps are used by institutional traders. A retail or individual trader can trade volatility through options, but a pure volatility bet would involve hedging out the delta (directional) risk.
Why do variance swaps have Delta?
Volatility swaps can have a delta due to the discretization of time and due to volatility surface dynamics in exactly the same way as a variance swap.
What is a variance swap?
A variance swap is analogously a forward contract on future realized price variance, which is the square of future realized volatility. In both cases, at inception of the swap the strike is chosen such that the fair value of the swap is zero. This strike is then referred to as fair volatility and fair variance, respectively.
What is fair volatility and fair variance in swaps?
In both cases, at inception of the swap the strike is chosen such that the fair value of the swap is zero. This strike is then referred to as fair volatility and fair variance, respectively.
What is the difference between variance and volatility options?
However, these options are also sensitive to the underlying asset price, as the delta of a straddle or a strangle is zero only when the option is at-the-money. Unlike these options, variance and volatility swaps provide pure exposure to volatility. A volatility swap is essentially a forward contract on future realized price volatility.
Why is the delta of the variance swap so small?
The delta of the variance swap is very small; it is different from zero, because the replication with just ten options is not perfect. After two weeks we compute the present value of the variance swap. For simplicity we assume that all inputs including the volatility smile are the same, except for the value date which is now March 17.