Drivers of Variance Swaps levels

We saw that VS levels move in close step with options IV --> driven mostly by same factors but also by shape of skew curve. 


  • Historical realised volatility

-  one of the most important drivers of VS levels at least at shorter maturities

- correlation between 1m VS and volatility realised over the previous month is 0.91 (R2 = 0.83).

- as maturity increases --> correlation between VS prices and realised volatility decreases. 


  • Risk-aversion 

VS prices carry a significant skew component. 

Risk-aversion --> demand for protection in form of put options --> skew/skew convexity increases --> impact VS prices. 


  • Market level

Volatility itself is directional, at least over short time frames, with volatility tending to increase if market sells off. 


Additional info: 

VS flows can have a feedback effect into the market. 

VS account for an important part of the traded vega demand, VS hedging by market makers can influence IVs and skews. 




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