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- first mentioned in th 1990's

- only really took off following dvlpmt of robust pricing models through replication arguments



- grown steadily --> investor demand to take direct volatility exposure without cost/complexity delta-hedging options. 



- has increased

- VS levels now deviate from theoretical price obtained from replicating ptf of options

--> partly because construction of replication ptf includes a relatively large contribution from deep OTM options and their reduced liquidity gives rise to some discrepancy in the overall pricing of VS. 

- bid/offer spreads have come in significantly over recent years --> this trend should continue as liquidity still improving. 

- bid/offer ~ 0.5 vegas on indices in developed markets

- bid/offer ~ 1-2 vegas on liquid single-stocks 

- spreads are naturally higher in emerging markets

- most liquid generally from 3m to 2y, although indices and liquid stocks have VS to 3y-5y and beyond

- is concentrated on equity markets --> IBs need to recycle volatility and correlation exposures from structured products


Maturities generally coincide with the quarterly options expiry dates.

This means that they can be efficiently hedged with exchange-traded options of the same maturity. 


Volatility Indices: VIX, VSTOXX, VDAX, ... 

represent the theoretical prices of 1m variance swaps

- are calculated by the exchanges from listed option prices, interpolating to get 1m maturity. 

- are widely used as benchmark measures of equity market risk. 


Typical Sizes: 

- € 100k – €200k vega notional for indices

- € 50k vega notional for single-stocks 


Forward variance and index variance spreads (ex: SX5E vs. SPX) are increasingly quoted with a single bid/offer spread, often comparable to, or only slightly higher than, the spread on a single leg, meaning the second component of the spread can effectively be traded at mid-market levels. 


More recently, the investor base has widened further with the advent of structured products which embed variance swap returns. Such products may be leveraged and/or offer capital guarantees, making them attractive to a broader range of institutions including private banks and sophisticated private investors. 



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