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16-1 swaps forwards and futures strategies (4 uses of derivatives in…
16-1 swaps forwards and futures strategies
1 introduction
typical
applications
modifying investment position
for hedging purpose
taking directional bets
creating or replicating desired payoffs
inplementing asset allocation and
portfolio rebalancing
inferring current market expectations
2 changing risk
exposures with
swaps futures
and forwards
3
derivatives
on volatillity
volatility
futures
and
options
the CBOE volatility index - VIX - the fear index
volatility futures - allow to implement views depending on expectation about timing and magnitude of a change in implied volatility
volatility expected to remain stable over near to long term -
the term structure of VIX future is flat -
expect more volatility in short term and require higher price for shorter-term contracts
expectation increasing long-term volatility - the VIX will rise - being in contango and upward sloped curve
the VIX futures are in contango - the cost of rolling over hedges increases - reducing profits and causing the ETP to underperform
variance
swaps
have a valuable convexity feature -
volatility increase, the positive swap payoffs increase
used for taking directional bets on implied versus realized volatility for speculative or heding purpose
the realized variance greater than swap's variance strike - the payoff of long variance position will positive -
the swap seller pays the buyer
Settlement amount_T =
(Variance notional)(Realized variance – Variance strike)
Realized variance = 252×[ ∑ (R_i)^2 / (N−1)]
the variance swap payoff is convex and
not linear for change in realized volatility
the exact payoff: Variance notional =
（Vega notional） / (2 × Strike price）
Settlement amount_T =
N_Vega
((σ^2−X^2) / (2×Strikeprice)) = N_variance
(σ^2−X^2)
the value of variance swap at time t :
VarSwap_t = Variance notional × PV_t(T) ×
{t/T × [Realized Vol(0,t)]^2 + (T−t)/T × [Implied Vol(t,T)]^2 − Strike^2}
the sensitivity of variance swap to changes in implied volatility diminishes over time
payoffs are convex in volatility - being long a variance swap equivalent to long a basket of options and short underlying asset
compare
traditional long volatility heding methods - assessed on the basis of ability to reduce portfolio risk and improve return
systematically short volatility - attempting to capture the risk premium embedded in option prices - most profitable under stable market conditions
4 uses of derivatives
in portfolio management
examples and solutions
equity swaps
cash equitization
asset allocation
using derivatives
using derivatives to infer
maket expectations