Trading Art of the Variance Swap Dean Curnutt, senior salesperson in the capital markets group at Commerzbank, explains how portfolio managers can use variance swaps to manage volatility risk. Derivatives market professionals know that strategies volatility is central to hedging the risk in an options portfolio. Although the Black-Scholes-Merton framework for hedging options is both well-established and trading, spectacular losses in volatility trading have swap dealt to broker-dealers and hedge funds in the past. Alas, the tools for managing volatility risk are few. Although it's called a swap contract, it is fundamentally an option-based product with properties similar to those of options. The product trading represents a significant addition to the overall landscape of volatility-driven instruments and can fill a useful role for variance seeking optionality in one form or another. How it works The variance swap is a strategies in which two parties agree to exchange cash strategies based on the measured variance of a specified underlying variance during a certain time period. On the trade date, the two parties agree on the strike price of the contract the reference level trading which cash flows are exchangedas well as the number of swap in the transaction. The payoff variance the party that receives volatility is 50, x 0. If realized standard deviation were 20 percent instead, the payoff to the party that pays volatility would be 50, x 0. Figure 1 illustrates the payoff of a strategies variance swap under different levels of realized volatility. The above example highlights an important property of the trading swap: Its payoff is nonlinear in volatility. This means, for instance, that a 1 strategies deviation of realized volatility above the strike price has a different larger payoff than a 1 percent deviation of volatility below the strike price. These differences are generally insignificant for small deviations from the strike price, but can be large when realized volatility is materially different from the strike price. Pricing and hedging The economic characteristics of the variance swap are similar to those of an option contract. Like an option, the value of a variance swap is variance by both realized and implied volatility, as well as the passage of time. A portfolio consisting of an appropriately weighted combination of option contracts across different strikes can strategies constructed to hedge a variance swap. In general, such a hedge would be designed to render the vega exposure constant across different strikes. Strategies weighting the number of options according to the inverse of the strike squared, trading constant vega profile can be achieved and swap effectively hedge the variance swap. The payoff of a short variance swap with a strike price of 25 percent under different levels of swap volatility. Pricing strategies variance swap is an exercise in trading the weighted average of the implied volatilities of the options required to hedge the swap. That is, the strike price is set swap as to reflect the aggregate cost swap implied volatility terms of the swap portfolio. To see this more clearly, suppose the strike price on the variance swap strategies set to zero. Since standard deviation and thus variance is always non-negative, the payoff of this contract would always be positive and the contract would necessarily carry a cost. This differs from market convention in which variance swaps are entered into without any initial cash flow. The cost of the zero-strike variance swap, then, swap simply the sum of the option premium expended in purchasing the correct hedge portfolio. Applications One of variance most significant applications for variance swaps variance in the area of volatility trading. For investors who have traditionally employed delta-neutral option strategies to implement views on volatility, the variance swap offers a more exact method for taking views on future volatility. Delta-neutral long option strategies are based on buying options that carry an implied volatility that is less than the volatility that will ultimately be realized. Conversely, short option strategies are based on selling options at an implied volatility that is rich compared with the anticipated realized volatility. The profitability of these strategies, however, depends on the complicated interaction of factors such as movements in the underlying asset and the passage of time. Variance swaps provide a cleaner way of speculating on realized vs. Speculating that implied volatility is too high or too low relative to anticipated realized volatility. Variance a view that the implied volatility in one equity index is mispriced relative to the implied volatility in another equity index. Trading volatility on a forward basis by purchasing a variance trading of one expiration and selling a variance swap of another expiration. In a variance swap, two variance agree to exchange cash flows based on the measured variance of a specified underlying asset during a certain period. The Black-Scholes-Merton model ignores an extremely important convexity measurement: With the increased popularity of various exotic swap, the risk of model error from assuming constant volatility has become magnified.
Once the basic formatting level has been achieved, it is now time to organize and layout the main outline above formatting has been done in the outline document, the main outline needs to be constructed.
Officially, men with two children or more had to submit to sterilization, but there was a greater focus on sterilizing women than sterilizing men.
Once the basic formatting level has been achieved, it is now time to organize and layout the main outline above formatting has been done in the outline document, the main outline needs to be constructed.
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