Volatility Library

Article by: Emil S. F. Stamp, Thomas F. Thorsen
Published by: Department of Business Studies, Aarhus University
Date: Aug 2011

“Volatility has always been considered a key measure within the field of finance. Financial markets have changed significantly over the last century and the recent financial crises have reshaped the markets in such a way that the role of volatility has become even more pronounced than it was before. The concept finds its use within important areas such as risk management, valuation and asset pricing in general, trading and many more.

“Increased market complexity have historically spurred the demand for more exotic derivatives for directional trading and hedging. In the 1990s a new asset class arose which provided the investor with the opportunity to take a direct position, not in the underlying itself, but in its volatility. With this new derivative class, volatility is no longer viewed as side product inherent in other derivatives, but as an independent asset class of its own. Variance and volatility swaps were the first and most fundamental products to be introduced in this asset class and ever since their introduction, the market for them has exploded. The products are in nature forward contracts which at maturity exchange the difference between a fixed strike and realized variance/volatility, scaled by a predetermined notional. Both are traded OTC which makes it difficult to assess the true market size but recent estimates indicate daily trading volumes of more than $35 million notional. Both market and academic interest for these products has increased in line with demand and much research has recently been devoted to develop efficient pricing methods.”

Full article (PDF): Link

Article by: Lewis Biscamp and Tim Weithers
Published by: Chicago Trading Company, LLC
Date: ?

“Over the past several years, equity-index volatility products have emerged as an asset class in their own right. In particular, the use of variance swaps has skyrocketed in that time frame. A recent estimate from Risk magazine placed the daily volume in variance swaps on the major equity-indices to be US$5m vega (or dollar volatility risk per percentage point change in volatility). Furthermore, variance trading has roughly doubled every year for the past few years.

“Along with the proliferation of the breadth and complexity of available volatility products has come increased anxiety and confusion about how investors can most effectively and efficiently trade volatility. We offer a brief overview of the concept of variance and volatility; describe how a variance swap can be used to trade equity-index volatility; and illustrate some advantages that variance swaps offer over other volatility-based assets. Lastly, we will describe how CBOE variance futures contracts are essentially the same as an OTC variance swap.”

Full article (PDF): Link