What is the difference between a volatility swap and a variance swap? How can views on price correlation be expressed?

Our Equity Derivatives Training Course offers several insights into the many different aspects of this topic.  This course is offered on an in-house basis and if you are interested please contact us to discuss your specific needs. Exchange-traded futures are the building block of the equity derivative product suite.  These products can reference both single stocks as well as indices.  Equity swaps are essentially multi-period futures contracts and are mainly traded on an over-the-counter basis.

The equity swap product allows investors to express views on how individual stocks or indices are expected to move. For example, a US investor wishing to take exposure to the Chinese market could trade a USD denominated swap that references a particular asset in that market.  By using an equity swap the investor is not required to buy the underlying asset.

From an investor’s perspective, options could be used for a variety of reasons, which include:

  • Expressing directional views
  • Portfolio downside protection
  • Trades that benefit when the markets are either volatile or range-bound
  • Yield enhancement

Exotic options include so-called path-dependent structures (e.g. barrier options) or correlation-dependent instruments (e.g. ‘worst of’ options). These can be used on a standalone basis but are also embedded within structured products that can be offered to a wider range of potential investors.

Dividend futures and options are gaining in popularity as they allow investors to isolate the dividend exposure of a given stock or index.    

Along with the FX markets, equity derivatives have a long history of product innovation.  Arguably they were amongst the first asset classes to develop instruments that allow investors to trade variance / volatility and covariance / correlation.  Probably the most widely- known instrument in this area is the VIX future which references equity index volatility and is sometimes referred to by the popular press as the ‘fear index’.  However, it is also possible to trade volatility and variance in either swap or option format.

One of the firm’s principals has written a text book on the subject entitled “Equity Derivatives: Corporate and Institutional Applications“.  The book is available from Amazon

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