Historical Prices

Observations from historical variance swap prices: 

 

  • They tend to follow high and low regimes in a similar manner to realised variance.

 

  • Longer maturity VS levels vary less and react less to spikes.

A sudden unexpected event: 

- likely to dramatically increase ST volatility dramatically

- less likely to cause the same level of elevated volatility over the next few years

 

  • Single-stock variance swaps generally trade at higher levels than index variance.

- diversification effect

- single stock variance can increase substantially in times of high company uncertainty

 

  • Variance swap levels are well correlated with realised volatility

VIX gives a proxy for rolling 1-month maturity variance swap levels on SPX. VS levels follow the underlying pattern of volatility regimes.

 

  • Variance swaps tend to trade somewhat above levels of realised volatility

2 distinct reasons: 

- variance swaps are convex in volatility --> VS buyer should fairly pay for convexity --> VS > ATM IV 

- volatility risk premium: investor risk aversion and hedging programmes -->  ATM IV > RV   

 

Simple framework:    VS > ATM IV > RV

- Vanilla option IVs trading above prevailing RV due to the volatility risk premium (~2-3 vegas)

- VS levels trading above ATM IVs due to the convexity premium (~ 1-2 vegas)

 

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