# What’s the difference between a variance swap and a long straddle option trade?

## 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.

## How does a variance swap work?

How a Variance Swap Works. Similar to a 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.

## When you would use a long straddle?

A long straddle is established for a net debit (or net cost) and profits **if the underlying stock rises above the upper break-even point or falls below the lower break-even point**. Profit potential is unlimited on the upside and substantial on the downside.

## What is the motivation to use variance swap?

Holders use variance swaps **to hedge their exposure to the magnitude of possible price movements of underliers**, such as exchange rates, interest rates, or an equity index.

## 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.

## How do you value a variance swap?

The variance swap replication is accomplished **using a portfolio of options with different strikes**. The construction of this portfolio can be understood intuitively in the Black Scholes model. The sensitivity of a European option to the variance of the underlying asset price depends on the asset price.

## Is variance and volatility the same?

**While variance captures the dispersion of returns around the mean of an asset in general, volatility is a measure of that variance bounded by a specific period of time**. Thus, we can report daily volatility, weekly, monthly, or annualized volatility.

## Does variance swap have Delta?

**The delta of a variance swap is its price sensitivity to the movement of the underlying asset**: ≡ ∂ V ∂ So . The purpose of this short article is to derive an analytic formula for a variance swap delta. It shows that the delta is determined by the volatility skew and the vega of vanilla options only.

## How does volatility swap work?

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.

## What is a gamma swap?

A gamma swap on an underlying Y is **a weighted variance swap on log Y , with weight function**. **w(y) := y/Y0**. (1) In practice, the gamma swap monitors Y discretely, typically daily, for some number of periods N, annualizes by a factor such as 252/N, and multiplies by notional, for a total payoff.

## What is a covariance swap?

**A covariance forward contract of two underlying prices/rates**. This swap pays the excess of the realized covariance between two assets (such as currencies) over a constant specified at the contract date.

## What is vega notional in variance swap?

The vega notional represents **the average P&L for a 1% change in volatility**. The vega notional = variance notional * 2K. The P&L of a long variance swap can be calculated as: When RV is close to the strike, the P&L is close to the difference between IV and RV multiplied by the vega notional.

## How do you find the notional variance?

Variance swaps typically have a notional amount quoted in approximate Vega terms (a dollar value per volatility point). For example, 100,000 USD vega notional. Given any strike (quote in volatility, eg 15%), you can determine the variance notional: **Variance Amount = Vega Notional / Strike*2**.

## What does vega notional mean?

The Vega notional is **the approximate cash gain or loss for a 1% difference between the volatility strike** (based on the implied volatility in at-the-money option on the underlying) and realized volatility over the life of the volatility swap (really a forward contract on volatility).

## Why are swaps used?

Swap is used **to have access to new financial markets for funds by exploring the comparative advantage possessed by the other party in that market**. Thus, the comparative advantage possessed by parties is fully exploited through swap. Hence, funds can be obtained from the best possible source at cheaper rates.

## What are the two types of swaps?

**Types of Swaps**

- #1 Interest rate swap. Counterparties agree to exchange one stream of future interest payments for another, based on a predetermined notional principal amount. …
- #2 Currency swap. …
- #3 Commodity swap. …
- #4 Credit default swap.

## What are two advantage of swapping?

Swapping allows companies to revise their debt conditions to take advantage of current or expected future market conditions. **Currency and interest rate swaps are used as financial tools to lower the amount needed to service a debt** as a result of these advantages.

## What is swap in simple words?

Definition: Swap refers to **an exchange of one financial instrument for another between the parties concerned**. This exchange takes place at a predetermined time, as specified in the contract. Description: Swaps are not exchange oriented and are traded over the counter, usually the dealing are oriented through banks.

## What is the difference between switch and swap?

**Swap means “exchange”, while switch means “change”**. Swap (to me) implies replacing some physical object with another. Switch means changes from some property, location, or attribute to another. Also, swapping usually implies exactly two entities having a role in the play.

## How do swap dealers make money?

**A fixed-rate payer (e.g. a swap dealer) of a cancellable swap pays more interest than he receives** because he has the right to terminate the swap after a certain time if rates fall.

## What is a 5 year swap?

5-Year Mid-Swap Rate Quotation means, in each case, the arithmetic mean of the bid and offered rates for the semi-annual fixed leg (calculated on the basis of a 360-day year of twelve 30-day months) of a fixed-for-floating U.S.

## What is today’s swap rate?

Swaps – Monthly Money

Current | ||
---|---|---|

1 Year |
3.214% |
0.124% |

2 Year | 3.393% | 0.245% |

3 Year | 3.324% | 0.454% |

5 Year | 3.178% | 0.838% |

## What is the 10 year swap?

The “10-year Swap Rate Quotations” means the arithmetic mean of the bid and offered rates for the annual fixed leg (calculated on a 30/360 day count basis) of a fixed-for-floating euro interest rate swap which (i) has a term of 10 years commencing on the first day of the relevant Interest Rate Period, (ii) is in an …

## Are swap rates risk free?

Because a Treasury bond (T-bond) is often used as a benchmark and **its rate is considered to be default risk-free**, the swap spread on a given contract is determined by the perceived risk of the parties engaging in the swap. As perceived risk increases, so does the swap spread.

## Why do swaps spread negatively?

Perhaps the most notable reason for negative swap spreads has been regulation. **The regulatory requirement for central clearing of most interest rate swaps (except for swaps with commercial end users) has removed counterparty risk from such swap contracts**.

## What is long swap spread?

In trading terms, **a bet that the spread between swap interest rates and government in- terest rates will widen** is called being long the spread. 1 A bet that the spread between swap interest rates and government interest rates will shrink is called being short the swap spread.