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3rd Generation Products: Gamma Swaps / Corridar VS/ Conditional VS

Generalised variance swaps or “3rd generation products” include gamma swaps, corridor swaps and conditional variance swaps.


Gamma swaps are very similar to variance swaps but maintain a dollar gamma linear with spot, rather than a constant dollar gamma, leading to lower a skew exposure and a slightly lower strike compared to standard variance swaps.


The original corridor variance swaps only accrue variance within a pre-specified range, meaning a long would make a maximal loss when the underlying fails to trade within the range.


Conditional variance swaps have been the most popular of these products, allowing investors to take exposure to realised variance contingent upon the underlying instrument trading within a pre-specified range. Outside this range no P&L accrues. Conditional variance swaps can be useful for hedging complex volatility exposures, taking a view on the volatility levels encapsulated in the skew or buying/selling variance at more attractive levels given a view on the underlying.

As with variance swaps, the sign of the P&L for a conditional variance swap is controlled by the difference between the volatility realised (in the range) over the lifetime of the swap and the pre-agreed fixed strike level. In the case of the conditional, P&L is accrued only when the underlying is within a pre-specified range. In addition, the magnitude of the final P&L is scaled by the proportion of time the underlying has spent in the pre-specified range. If the underlying trades entirely outside the range, the P&L will be zero, so the maximal loss for a long will be when the underlying trades within the range but with very low volatility.

Whilst investors are free to specify the range associated with a conditional variance swap, the two principal types are up- and down- conditional variance swaps (up-variance and down-variance). Up-variance accrues realised volatility only when the underlying is above a pre-specified level (i.e. no upper barrier), while down-variance is accrued only when the underlying is below the specified barrier (i.e. no lower barrier).

In the presence of a positive put-skew, down-variance will normally price above up-variance for close to ATM barrier levels. 


Conditional vs


Conditional variance swaps can be useful for expressing views on volatility contingent on market level.

For example investors seeking crash protection may purchase conditional down-variance, which only becomes activated in the event of a market sell-off. That is, if the market stays above the down-barrier, P&L is zero.

Conversely investors who believe volatility will be realised on the upside can buy conditional up-variance swaps, which are usually cheaper than a standard variance swap for which a significant amount of the premium is used to fund the downside skew exposure.


Conditional variance swaps have typically been traded on index underlyings. More recently, single-stock conditionals have gained liquidity, allowing investors to trade the volatility of a stock, contingent on stock price. 




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