Exploiting a volatility view

The most obvious use for variance swaps is to express a direct view on the volatility of the underlying.


Delta-hedged options can be used for this purpose but have two principal drawbacks:

  • The delta-hedging requires active management (human & transaction costs).

  • The volatility exposure is path-dependent. 


Variance swaps have none of these issues and provide a pure exposure to volatility.


  • At the index level, investors may use variance swaps to express a macro view. 
  • On single-name underlyings, variance swaps could be used to take a view on the uncertainty of a company. 
  • Another use of variance swaps is to take advantage of an expected structural change in a company. 
  • Variance swaps can also be used by investors to express their view on the likelihood of an M&A event. 


Example 1:

Bull market, an investor expects a sharp downwards correction at some stage in the future, say within a year. 

- he does not want to sell his position as market may rally further. 

- put options are possibility for hedging but will need to be re-restruck to roll up protection as market rallies. 

- long VS can prove profitable if correction relatively sudden and occurs within maturity of the VS. 


However, the investor: 

- must be careful to maintain the required volatility exposure

- must consider whether an exposure to RV is desirable

- must compare the negative carry from holding long VS position to the put premium


Example 2:

An investor expects a quiet market, which may gradually trend up. He wants to boost his alpha based on this view. 


- Straddles are not perfect:

  • low vol market often displays trending behaviour  --> delta-hedging
  • even delta-heding will prove sub-optimal --> away from strikes --> decreased exposure to volatility through decreased gamma. 


- Selling VS is efficient and non-path-dependent way of capitalising on this low volatility view. 


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