What Is a 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 asset⛎s 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.

A variance swap is quite similar to a 澳洲幸运5官方开奖结果体彩网:volatility swap, which utilizes realized volatility inst🎐ead of variance.

How a Variance Swap Works

Similar to a 澳洲幸运5官方开奖结果体彩网:plain vanilla swap, one of the two parties involved in a var swap transaction will pay an amount based upon the actual variance of price changes of the underlying asset. The other party will pay a fixed amount, called the strike, specified at the start of the contract. The strike is typically set at the onset to make the 澳洲幸运5官方开奖结果体彩网:net present value (NPV) of the payoff zero.

At the end of the contract, the net payoff to the 澳洲幸运5官方开奖结果体彩网:counterparties will be a theoretical amount multiplied by the difference between the variance and a fixed amount of volatility, settled i𝓰n cash. Due to any margin requirements specified in the contract, some payments may occur during the life of the contract should the contract's value move 🌊beyond agreed limits.

The variance swap, in mathematical terms, is the arithmetic average of the squared differences from the mean value. The square root of the variance is the 澳洲幸运5官方开奖结果体彩网:standard deviation. Because of this, a variance swap's payout will be larger than that of a volatility swap, as the basis of these products is at variance rat𓄧her than the standard deviation.

A variance swap is a pure-play on an underlying asset's 澳洲幸运5官方开奖结果体彩网:volatility. Options also give an investor the possibility to speculate on an asset's volatility. But options carry directional risk and th𒆙eir prices depend on many factors, including time, expiration, and implied volatility. Therefore, the equivalent options strategy requires additional risk hedging to complete. Variance swaps are also cheaper to put on since the equivalent of an option involves a strip of options.

Thereಞ are three main classes of users for variance swaps꧂.

1. Directional traders use these swaps to speculate on the future level of volatility for an asset.
2. Spread traders merely bet on the difference between realized volatility and 澳洲幸运5官方开奖结果体彩网:implied volatility.
3. Hedger traders use swaps to cover short volatility positions.

Additional Variance Swap Characteristics

Variance swaps are well suited for 澳洲幸运5官方开奖结果体彩网:speculation or hedging on volatility. Unlike options, variance swaps do not require additional hedging. Options may require 澳洲幸运5官方开奖结果体彩网:delta-hedging. Also, the payoff at maturity to the long holder of the variance swap is always positive when realized 𒀰volatility is more significant than the striꦯke.

Buyers and sellers of volatility swaps should know that any significant jumps in the price of the 澳洲幸运5官方开奖结果体彩网:underlying asset canꦦ skew the variance and produce unexpecte🥂d results.