variance swaps

[straddle_me]

Any variance swap traders out there?

what is 'shadow delta' vs plain delta on a variance swap. i assume it has something to do with the way the payout is calculated on the swap and each daily fixing.

how are variance swaps normally hedged? do you really buy/sell the whole strip of vanilla's against it, or just some parts of the curve, or atm straddles, etc...?

i'm hearing of trading put spreads against them; would you delta hedge those options, or ride them out against the variance?

thanks

 

[riskarb]

Variance swaptions. Hedging with strip-vol would require a ridiculous amount of capital to effect.

 

[straddle_me]

that's what i thought. i guess most speculators would just take their view, execute the swap and let it ride, maybe put on a few straddles if they want to hedge or play the skew.

but how would a market-maker hedge a variance swap? let's say he makes a market (bid-offer), how does he ensure that he won't lose money on the trade (i understand no guanrantees...) if he doesn't want to hold the side he takes versus the client?

 

[riskarb]

Quote from straddle_me:

that's what i thought. i guess most speculators would just take their view, execute the swap and let it ride, maybe put on a few straddles if they want to hedge or play the skew.

but how would a market-maker hedge a variance swap? let's say he makes a market (bid-offer), how does he ensure that he won't lose money on the trade (i understand no guanrantees...) if he doesn't want to hold the side he takes versus the client?

Pricing is a function of hedging-efficiency, so you can imagine these are wide-markets. A call or put swaption into your exposure, but that would require another market to be made. It's a difficult price-discovery, as there is no consensus on what to use... Heston > StochVol > [many others] and the things aren't traded in continuous-time. No time and sales on these.

You could price the variance-vols directly from the liquid underlying and use a vanilla model.

 

[sle]

Quote from straddle_me:
but how would a market-maker hedge a variance swap?

actually, they can be hedged statically in options and dynamically in underlying. in essense, you are creating a inverse log-like payoff profile using a collection of options (easy for a market-maker these days, as everyone wants to sell wings) and you hedge the delta exposure. i'll send you a pm with more details.

 

[Saion]

Any variance swap traders out there?

what is 'shadow delta' vs plain delta on a variance swap. i assume it has something to do with the way the payout is calculated on the swap and each daily fixing.

how are variance swaps normally hedged? do you really buy/sell the whole strip of vanilla's against it, or just some parts of the curve, or atm straddles, etc...?

i'm hearing of trading put spreads against them; would you delta hedge those options, or ride them out against the variance?

thanks

Sorry for jumping in late. I just joined this forum.
So... you hedge var swaps EOD using change in position deltas at the close-close. For ex,
As the payout of variance swaps is based on the close-to-close return, they all have an intraday delta (which is equal to zero if spot is equal to the previous day’s close). As this intraday delta resets to zero at the end of the day, the hedging of these products requires a delta hedge at the cash close. A rule of thumb is that the direction of hedging flow is in the direction that makes the trade the least profit.
If spot has risen over the day the position (which was originally delta-neutral lets say) has a positive delta (in the same way as a delta-hedged straddle would have a positive delta if markets rise). The end of day hedge of this position requires selling the underlying (to become delta-flat). Also, If markets rise, the delta of the position is negative and, as the variance swap delta is reset to zero at the end of the day, the trader has to buy equities at the same time.
I hope I answered your question. Also, do you happen to know any softwares where I can look at shadow deltas of my positions or lets say for the market based on spot-vol movement?

 

[qwerty11]

Any variance swap traders out there?

How can anyone do them here? I guess these are/were only offered by banks to institutional customers during the last 15 years? Do you expect retail to ever had access to variance swaps (other than SPX maybe)?