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- Drivers of Variance Swaps levels
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.