Variance swap

A swap paying the difference between realised variance and a strike variance fixed at the start, scaled by the variance notional. Because variance is volatility squared, the payoff is convex in volatility.

Where you will meet it

Variance swap appears in 2 learning outcomes on the CFA syllabus. A few of them:

• Discuss specialist hedge fund strategies: their investment features, how they are put into practice and the role they play in a portfolio
  CFA Level II · Alternative Investments

  “Volatility traders trade volatility itself through options, VIX futures and variance swaps; a long-volatility book acts as a tail hedge that gains in sharp sell-offs but bleeds option premium in calm periods, while short-volatility books collect premium with severe left-tail risk.”

• Show how volatility derivatives, including variance swaps, are used in practice
  CFA Level III · Derivatives and Risk Management

  “A variance swap pays variance notional × (realised variance − strike variance), where variance notional = vega notional ÷ (2 × strike volatility).”

See also

Variance · Variance notional

Practise it

• Today's practice question One question, with every wrong option explained.
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All terms beginning with V · Glossary