I understand that an investor who has a view on an underlying's variance would be tempted by a variance swap. But why would one prefer such a contract over another instrument whose value is based on volatility, eg. options ?

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    $\begingroup$ There are adv and disadv to both. For example options are exchange traded (more transparent, easier to access) while varswaps are OTC. However a portfolio of options is more complex to manage than a single varswap. And so on. $\endgroup$
    – Alex C
    Commented Jun 12, 2016 at 1:22
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    $\begingroup$ @AlexC it would be better to write a complete answer if possible, here we can feel you know a lot on the topic so it would benefit the site to have an elaborate answer. $\endgroup$
    – SRKX
    Commented Jun 12, 2016 at 8:43

2 Answers 2


Clearly, from a theoretical point of view, a varswap is a better way of capturing volatility change, since as mentioned by Mark Joshi a varswap has, by construction, a Vega that does not vary with the stock price. For a single option on the other hand the Vega is at maximum at a stock price $S^*$ roughly comparable to the strike price X and decays in a "bell shaped" fashion for stock price higher or lower than this. (The modal Vega stock price is $S^*=X\exp((-r-\frac{\sigma^2}{2})T$), "below but close to X", as Mario Draghi would say).

When you are betting on volatility and not on the stock price you would clearly prefer to have a fixed Vega (i.e. a fixed sensitivity to vol), unaffected by stock price movement.

This could be also accomplished by having a portfolio of options of various strikes, some above and some below the current stock price, so you have all bases covered if the stock price starts to move up or down between now and maturity. And, amazingly enough, it is by analyzing this strategy that theoreticians have come up with the formulas for valuing varswaps. It is the same logic.

From a practical point of view buying a static portfolio of many options is more difficult to deal with than buying a single varswap. The varswap is more convenient.

But from a practical point of view the varswap also has a disadvantage. The varswaps are OTC instruments traded by a few major IBs only. (Unlike the CBOE traded index options). The prices of varswaps are not published in the WSJ or anywhere else, and as far as I know there has been no academic study of the varswap market pricing, liquidity, efficiency, etc. because the research data is not available. Until then therefore, I will personally stick with index options and VIX futures when I trade volatility.


The vega of an option is very dependent on the spot price. The vega of a variance or volatility swap is not.


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